In the period after debt financing becomes available, the students are given the option of raising equity capital within the simulation.
The student teams are also limited in the amount of equity capital they are able to raise based on the financial condition of the company. The decision screen for equity allows for equity issuance, share repurchase, and dividend payments and can be seen in Exhibit These effects partially offset each other, but the overall impact on share price to an equity issue is generally negative. The other option available on the equity decision screen seen in Exhibit 2 is the ability to pay a dividend. The fact that dividends have a positive effect on share value tends to support the Gordon or Lintner proposition that dividend payments increase firm value as opposed to the dividend irrelevance theory of Modigliani and Miller Generally, teams only issue a dividend when there is no other more productive use of the cash.
The choice between debt and equity for external financing affords the opportunity to explore several additional capital structure considerations. Perhaps the most important distinction between the two sources of capital that is made obvious to the student is the discretionary nature of dividend payments on stock compared to interest payment obligations incurred with a bond issue.
Next, interest payments are a taxdeductible expense in the simulation while dividends are paid from after-tax profits. Finally, students observe the impact of leverage and cost of capital through analysis of the financing decisions within the simulation. Once the new product is launched, students will have three additional periods to refine their strategy and compete for the highest shareholder value. Indeed professors teaching the course observe that teams often overemphasize the importance financial strategies designed to improve shareholder value at the expense of other value-creating operational decisions.
Within each world, the teams with adequate cash spend the last three periods making decisions that are intended to drive the share price as high as possible. Further, many teams will use available cash to repurchase shares, pay off outstanding debt, and pay dividends in an effort to increase earnings per share, reduce the debt-to-equity ratio, and increase cumulative dividends paid.
The winning team is typically a team that had a successful product launch, excellent demand forecasting ability, and a thorough understanding of capacity planning and inventory management. Further, the winning teams always employ at least one, if not all, of the capital structure and dividend policy strategies described above.
In this paper we have focused on the key financial considerations of capital structure and dividend policy. The students are introduced to the concepts as a topic in Introduction to Business and the concepts are reinforced during the later Corporate Financial Management course. For finance majors, the topic is explored yet again in the required Intermediate Corporate Finance course.
At the end of the course, the professors in the course conduct a survey of the students. One of the questions seeks to gauge the student perception of understanding in each of the functional areas of business. The results of this survey question are presented in Table 2. A similar question asks them to rate their perceptions on learning with respect to specific learning goals. The results of this survey question are presented in Table 3. While student perceptions of learning are often biased, we interpret these results to mean that the students generally view the simulation as a valuable part of the course and useful learning experience.
The use of the simulation to introduce the capital structure and dividend policy concepts does present challenges. First, a student could possibly learn to correctly change the numbers in the decision screen within the simulation with little to no understanding of the underlying concept behind the impact on shareholder value. Indeed, many of the students that perform best in the simulation are not the same students that perform best in the course. Student grades are determined by exam scores, assignment grades, and a course project that requires synthesis of the course content with simulation outcomes.
Finally, the nature of the team decision-making does little to ensure that every student on each team fully understands the application of the concept. This evaluation helps ensure that all students are knowledgeable in the concepts developed during the exercise. First and foremost, it exposes the students to the different functional areas of business within a company, shows how decisions within those functional areas are interrelated, and demonstrates the importance of each for a successfully managed company.
For finance in particular, the positives far outweigh the negatives. Instilling the concept that maximizing shareholder value leads to success in business at an early stage of the curriculum establishes a solid foundation for students in the finance major. Understanding by beginning business students of the impact of capital structure and dividend policy on shareholder value, even at a very basic level, makes the simulation worth consideration for inclusion in an undergraduate business curriculum. Armenakis, A.
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