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Gainesboro Dividend Case Study

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Submitted By joeljunquan91
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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 shareholders are hinted that payment will resume soon. In addition, the aftermath of Hurricane Katrina has caused some uncertainty, resulting in a decrease of Gainesboro’s stock by 18%. Ashley Swenson, the CFO of Gainesboro now has to recommend an appropriate payout policy.
Dividend Irrelevance Proposition
Modigliani and Miller (1961) show that in perfect and complete capital markets,...

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