1.In theory, to fund an increased dividend payout or a stock buyback, a firm might invest less, borrow more, or issue more stock. Which of those three elements is Gainesboro's management willing to vary, and which elements remain fixed as a matter of the company's policy?
Gainesboro wants to increase value to shareholders but also keep paying dividends. However, the company's main concern is the debt to equity ratio. The cap Gaineboro set is at 40% and anything over this percentage is “unthinkable, indicative of sloppy management, and flirting with trouble” according to co founder David Scarboro. In 2004, the company had the highest debt to equity ratio in the past 25 years at 22% which ...view middle of the document...
Unused debt cap would be 15.5 million (40% debt maximum * the difference between equity and debt) EPS is about .90 base on the 18.6 shares outstanding.
b. a 20% payout is pursued?
Equity ratio would increase to 36.6 at a 20% payout. The unused debt would go down to 10 million and dividends would require an additional 3.7 million in financing. EPS would be .89 and dividend would be .20 per share.
c. a 40% payout is pursued?
If this payout was pursued the debt to equity ratio would increase to 38.4. This is considered very high to Gainesboro executives. They would need 7.3 million and unused debt capacity would only be 4.6 million. EPS would be .88 dividends paid per share would be .39.
d. a residual payout policy is pursued?
Residual dividend is a policy where a company uses residual or leftover equity to fund dividend payments. The method of dividend payment normally creates volatility in the dividend payments that may be undesirable for some investors.
However, I would suggest this policy the best approach to Gainesboro situation. I heavily suggest a dividend is paid out no matter how small it is to the shareholders. This was promised in an effort to signal that management is in control of the current and future operations.
This method offers the most flexibility of deciding a dividend only when you have the extra funds to do so and it will strongly decrease the reliance on external funds.
3.How might Gainesboro's various providers of capital, such as its stockholders and creditors, react if Gainesboro declares a dividend in 2005? What are the arguments for and against the zero payout, 40% payout, and residual payout policies? What should Ashley Swenson recommend to the board of directors with regard to a long-term dividend payout policy for Gainesboro Machine Tools Corporation?
As the case mentions having a zero payout policy would place the company's new and advanced technologies in a high growth and high technology category. However, if the market views Gainesboro as a traditional electrical company then they would expect strong capital appreciation and lower dividend payouts.
40% payout is based on amazing increase in sales and future orders. Having such a high dividend payout also shows a strong, positive market response. This strategy falls between industrial-equipment industry and machine-tool industry. This...