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Case 29 Gainesboro Machine Tools Corporation

In: Business and Management

Submitted By silver88
Words 1110
Pages 5
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 was still a discussion among senior management. Because of the company being so fixed on debt I think it is an unlikely the funds for 2005 will be used to finance dividends they promised. I do not think it should be an option at all, but I think their promise needs to be reevaluated.

Based on the history of this company paying equity to debt financing I am assuming that they will continue to issue more stock to finance the dividend versus the borrowing. Gaineboro new Artificial Workforce seems promising and this might be the last big leap for this company financial for a while. So base on this information I believe the company will issue more stock.

2.What happens to Gainesboro's financing need and unused debt capacity if:
Figuring the cost of debt (after-tax) is 6.5% (pre-tax 10%) and I picked 35% for a selected tax rate. I weighted the P/E ratio to reflect what was stated in the case that 75% of earning would come from the new projects (Artificial Workforce) and 25% from traditional molds and presses.

a. no dividends are paid?
Making a promise to shareholders and no delivering the promise happens all the time and it does not always mean for a negative market

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...EFB 360 Finance Capstone Case Study 2 Distribution to shareholder: Dividends and Repurchase The case of Gainesboro Machine Tool Corporation Abstract 1 Introduction 1 Dividend Irrelevance Proposition 1 Financial Flexibility 2 Agency Theory 2 Signalling Theory 3 Clientele Effects 4 The Optimal Payout Ratio 5 Share Repurchase 7 Conclusion 8 References 10 Appendices 13 Appendix 1: Detailed Calculation of Unused Debt Capacity (0%, 20%, 40% and residual payout) 13 Appendix 2: Residual Payout Calculations 15 Appendix 3: Sensitivity Analysis for Optimal Payout Ratio 16 Appendix 3.1 Debt/ Equity Ratio of 13% and 18% Annual Sales Growth 17 Abstract This paper reviews current literature to explore the financial effects of payout policy on signalling and clientele effects, as well as the financial implications of dividend and share repurchase decisions. Possible reactions that Gainesboro’s various capital providers may have to different payout policies are also examined, to determine an optimal payout policy for Gainesboro, taking into account contextual factors mentioned in the case. Findings suggest that although a 20% payout ratio is feasible, Gainesboro will most benefit from share repurchasing this quarter. Introduction Gainesboro Machine Tool Corporation has a tradition of strong earnings and predictable growth. However since 2000, dividends have started to outgrow earnings. By the first half of 2005, they have not declared dividends yet but...

Words: 2910 - Pages: 12