Eastboro Machine Tools Corporation

Eastboro Machine Tools Corporation

Problem Statement

When considering whether or not it is necessary to pay dividend, Eastboro Machine Tools Corporation is facing a problem, i.e. how to provide enough cash to ensure the upcoming aggressive growth in the following years. If dividend is necessarily paid, how much dividend will be paid to benefit the shareholders most in the long run?

Situation Analysis

After two massive restructurings, the firm seems to get in a quick track to development. Its product “Artificial Workforce” appears to have a bright future. Most of securities analysts are optimistic about the product’s impact on the company. That’s why Campbell took the boldest approach by assuming that the company would grow at a 15% compound rate.

However, we have noticed that whether or not the 15% growth rate could be achieved heavily depends on the financial decision and the dividend decision even if the firm has good opportunity to generate satisfactory free cash flow to firm (FCFF). Thus, in order to ensure the maximization of the shareholders’ long-term benefits, Ms. Campbell has to take a close look at how the dividend decision impacts the financial decision and the resultant effects on investment decision and the market values of the entire firm and the equity.

As the case indicates, Campbell has five options: Zero-dividend, 40%-dividend, Residual-dividend, stock repurchase and not to matter. In my mind, Campbell’s ultimate target is to guarantee enough cash to facilitate the materialization of 15% growth rate for the sake of maximizing the shareholders’ wealth.

Firstly, Campbell needs to compare the market values of the firm and the equity impacted by the alternatives to raise money, e.g., issue debt or issue stock, under the circumstances of the above five dividend options respectively. Here, the