...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
...GAINESBORO MACHINE TOOLS CORPORATION Teaching Note Synopsis and Objectives Other cases in which dividend policy is an important issue: “Deutsche Brauerei,” (Case 11) In mid September 2005, Ashley Swenson, the chief financial officer (CFO) of a large computer-aided design and computer-aided manufacturing (CAD/CAM) equipment manufacturer needed to decide whether to pay out dividends to the firm’s shareholders, or to repurchase stock. If Swenson chose to pay out dividends, she would have to also decide upon the magnitude of the payout. A subsidiary question is whether the firm should embark on a campaign of corporate-image advertising, and change its corporate name to reflect its new outlook. The case serves as an omnibus review of the many practical aspects of the dividend and share buyback decisions, including (1) signaling effects, (2) clientele effects, and (3) the finance and investment implications of increasing dividend payouts and share repurchase decisions. This case can follow a treatment of the Miller-Modigliani dividend-irrelevance theorem and serves to highlight practical considerations to consider when setting a firm’s dividend policy. Suggested Questions for Advance Assignment to Students The instructor could assign supplemental reading on dividend policy and share repurchases. Especially recommended are the Asquith and Mullins article on equity signaling, and articles by Stern Stewart on financial communication. 1. In theory, to fund an increased...
Words: 5756 - Pages: 24
...Case #25 Gainesboro Machine Tools Corporation Synopsis and Objectives In mid September 2005, Ashley Swenson, the chief financial officer (CFO) of a large computer-aided design and computer-aided manufacturing (CAD/CAM) equipment manufacturer needed to decide whether to pay out dividends to the firm’s shareholders, or to repurchase stock. If Swenson chose to pay out dividends, she would have to also decide upon the magnitude of the payout. A subsidiary question is whether the firm should embark on a campaign of corporate-image advertising, and change its corporate name to reflect its new outlook. The case serves as an omnibus review of the many practical aspects of the dividend and share buyback decisions, including (1) signaling effects, (2) clientele effects, and (3) the finance and investment implications of increasing dividend payouts and share repurchase decisions. This case can follow a treatment of the Miller-Modigliani[1] dividend-irrelevance theorem and serves to highlight practical considerations to consider when setting a firm’s dividend policy. Suggested Questions 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? 2. What happens to Gainesboro’s financing need and unused debt capacity if: a. no dividends are paid? ...
Words: 1798 - Pages: 8
...capacity if: a. no dividends are paid? b. a 20% payout is pursued? c. a 40% payout is pursued? d. a residual payout policy is pursued? Note that case Exhibit 8 presents an estimate of the amount of borrowing needed. Assume that maximum debt capacity is, as a matter of policy, 40% of the book value of equity. 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 the long-term dividend payout policy for Gainesboro Machine Tools Corporation? 4. How might various providers of capital, such as stockholders and creditors, react if Gainesboro repurchased its shares? Should Gainesboro do so? 5. Should Swenson recommend the corporate-image advertising campaign and corporate name change to the Gainesboro’s directors? Do the advertising and name change have any bearing on the dividend policy or the stock repurchase policy that you propose? You are required to present your case analysis both orally (presentation) and in writing (report format). Note: - 1. This is an individual assignment. 2. Be mindful of the danger of plagiarism. Referencing and bibliography are expected if any of your assignment is borrowed from any particular...
Words: 448 - Pages: 2
...Open market repurchases and employee options Kathleen M. Kahle* Katz Graduate School of Business, University of Pittsburgh, Pittsburgh, PA 15260, USA (Received 20 September 2000; accepted 6 June 2001) Abstract This paper examines how stock options affect the decision to repurchase shares. Firms announce repurchases when executives have large numbers of options outstanding and when employees have large numbers of options currently exercisable. Once the decision to repurchase is made, the amount repurchased is positively related to total options exercisable by all employees but independent of managerial options. These results are consistent with managers repurchasing both to maximize their own wealth and to fund employee stock option exercises. The market appears to recognize this motive, however, and reacts less positively to repurchases announced by firms with high levels of nonmanagerial options. JEL Classification:G30, G32 Key Words: share repurchase, executive stock options, employee stock options I thank Ken Lehn, Frederik Schlingemann, Kuldeep Shastri, René Stulz, Shawn Thomas, Cynthia von Skansen, Ralph Walkling, and an anonymous referee for helpful comments and suggestions. Tomas Jandik and Gang Hu provided excellent research assistance. * Tel.: 412 648 1519, Fax: 412 648 1693 E-mail address: kkahle@katz.pitt.edu 0304-405X/00$-see front matter © 2002 Elsevier Science S.A. All rights reserved 1. Introduction Early studies of open market stock repurchases document...
Words: 12612 - Pages: 51
...Share Repurchase: Is it good or bad? Financial Strategy (BMBA715.2) Date: 27th March 2013 Tutor: Mark Pilkington Author: Nandkumar Mahajan (136866461) Word Count: 3069 Table of Contents Executive Summary ............................................................................................................................. 3 Company capital structure & Shareholder value ...................................................................... 4 Why companies really repurchase shares? ................................................................................ 6 Is there any real value in share repurchase? ............................................................................. 7 Hewlett-‐Packard (HPQ) ................................................................................................................................ 7 Next Plc. (NXT) ........................................................................................................................................... 10 Conclusion ..................................................................................................................
Words: 4857 - Pages: 20
...that Wrigley can borrow $3 billion at a credit rating of BB to B, to yield 13%. Over the last few years, Wrigley has had revenue growth at an annual compound rate of 10% (earnings at 9%) which reflected the introduction of new products and foreign expansion. The firm has always been conservatively financed and had stock that was outperforming the S&P 500 composite index. The proposed leverage recapitalization would have Wrigley borrow $3 billion and use it to pay an equivalent dividend or repurchase an equivalent value of shares. This could increase the value of the firm by shielding the cash flows from taxes. An additional assumption is the debt rating for Wrigley, after they assume the debt would they be able to manage the interest payments. How does Chandler know that a rating of BB/B would be likely. Additionally, Chandler knew that the maximum value of the firm would be achieved when the WACC was minimized. Repurchasing of shares would alter the amount of shares outstanding which could also have an impact on the amount of the Wrigley family’s voting control. Chandler needed to ensure that her analysis covered all aspects of the restructuring and that she did not impact the Wrigley family’s voting control if they opted not to sell any...
Words: 974 - Pages: 4
...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 these three elements is Eastboro management willing to vary, and which elements remain fixed as a matter of policy? Management is willing to vary their investment (investing less) as well as issue more stock. This is not against their policy. But the management would not be willing to borrow more as their borrowing policy is limited to 40% debt to equity ratio. 2. What happens to Eastboro's financing need and unused debt capacity if , a. No dividends are paid? If no dividend are paid, the company does not need financing required for the dividends. Hence the company’s financing needs decreases. If the company pays 40% dividend, they need to borrow $30 million in 2001 and if no dividend is paid, they only need to borrow $23 million. Hence the unused debt capacity also increases if no dividend is paid. b. 20 percent payout is pursued? If 20% dividend payout policy is pursued, the amount needed for dividend would be $3.6 million as opposed to $7 million (with a 40% payout). The company requires less financing and hence the financing needs decreases as opposed to a 40% dividend payout. Also the unused debt capacity would decrease as the company needs to borrow $26.6 million as opposed to $30 million (with a 40% payout). c. 40 percent payout is pursued? If 40% dividend policy is pursued, the financing needs of...
Words: 1465 - Pages: 6
...able to grow substantially since its inception in 1981. More importantly to Termeer, because of its breakthroughs in creating medicine for rare diseases, Genzyme has also been able to change the lives of numerous individuals suffering from these diseases by developing a cure for some of them. Relational Investors, one of Genzyme’s primary stockholders, believes that even though Genzyme had a very good growth rate when compared to the rest of the biotechnology industry, Genzyme stock was still significantly undervalued. To fix this, Ralph Whitworth, the CEO of Relational Investors, offered some recommendations as to how Genzyme could fix this problem. These recommendations were: improve capital allocation decision making, either implement a share-buyback program or issue a dividend, add more board members to the Genzyme board of directors who had more financial expertise, and change board member compensation to reflect the performance of Genzyme. Termeer was very familiar with how ‘activist investors’ such as Ralph Whitworth operated. Having already fought of Carl Icahn, who sought major changes in the way Genzyme operated, Termeer knew how important his negotiations would be with Ralph Whitworth. These negotiations were a pivotal point in the history of Genzyme Corporation. If Termeer was able to fight of Whitworth as he had fought of Icahn, Genzyme would continue to operate as it normally had, but if Whitworth came out victorious in these negotiations, then major changes could potentially...
Words: 2105 - Pages: 9
...Foot Locker Inc. Liquidity Financing Activities • Net cash used was $181 million in 2012 as compared with $178 million in 2011 • Repurchased 4,000,161 shares of its common stock in 2012 for $129 million • Declared and paid dividends totaling $109 million and $101 million in 2012 and 2011 • Representing a quarterly rate of $0.18 and $0.165 per share in 2012 and 2011 • Received proceeds common stock and treasury stock, 2012 and 2011, $48 and $22 million • Recorded excess tax benefits compensation of $11 million and $5 million for 2012 and 2011 --------------------------------------------------------------------------------------------------------------------- Free Cash Flow Net cash flow provided by operating activities compared free cash flow. Uses free cash flow: • Measure of performance • Strength of the company • Ability to generate cash 2012 2011 2010 (in millions) Net cash provided by operating activities $ 416 $ 497 $326 Capital expenditures (163) (152) (97) Free cash flow (non-GAAP) $ 253 $ 345 $229 ---------------------------------------------------------------------------------------------------------------------Operating Activities Operating activities cash $416 million in 2012, compared...
Words: 500 - Pages: 2
...Lockheed Martin, Fiscal Year 2012 Donna K Falkenburg Professor Susan Lightweis Accounting 206 – Accounting II 6/02/2013 Lockheed Martin is a publicly traded, global security and aerospace company formed in 1995. They are principally engaged in the research, design, development, manufacture, integration, and sustainment of advanced technology systems and products. They are also known to provide a broad range of management, engineering, technical, scientific, logistic, and information systems. They serve both domestic and international customers with products and services that have defense, civil, and commercial applications. Their principal customers are the agencies of the U.S. Government. In 2012, 82% of their $47.2 billion in net sales were from the U.S. Government, in which they were a prime contractor or as a subcontractor. This includes 61% from the Department of Defense (DOD), 17% were from international customers, which includes foreign military sales (FMS) that were contracted through the U.S. Government), and 1% were from the U.S. commercial and other customers. Lockheed Martin’s main areas of focus includes defense, space, intelligence, homeland security, and information technology which includes cyber security. The organizational governance and structure of Lockheed Martin include a Board of Directors which is made up of ten (10) Executive officers. The positions range from Chairman which is held by Robert J. Stevens, to executive vice presidents...
Words: 846 - Pages: 4
...Polaris Industries, Inc. RATIOS Liquidity Polaris Current Ratios Current Ratio 2011: $878,676/$615,531 = 1.43 Current Ratio 2010: $808,145/$584,210 = 1.38 Current Ratio 2009: $491,500/$343,074 = 1.43 Debt to Assets Ratio 2011: $727,968/$1,228,024 = 0.59 2010: $690,656/$1,061,647 = 0.65 Profitability Return on Sales 2011: $227,575/$2,656,949 = $0.08 2010: $147,138/$1,991,139 = $0.07 2009: $101,017/$1,565,887 = $0.06 Growth 5 yr. annual growth – 13.35% 5 yr. revenue growth – 9.91% 5 yr. dividend growth – 7.74% 5 year EPS growth – 18.68% Investments Dividend Yield - $1.35/$79.90 = 1.6% (using 2011’s annual divided) Yamaha Current Ratios Current Ratio 2011: $561,205/$366,415 = 1.53 Current Ratio 2010: $639,028/$365,131 = 1.75 Current Ratio 2009: $620,800/$379,698 = 1.63 Polaris Industries Inc. OVERVIEW Polaris Industries Inc. is an international manufacturing company with a variety of product that falls under a general category of motorsports. They are based out of Medina, Minnesota and are one of the leading competitors in the industry. Their product line consists of snowmobiles, all-terrain vehicles (ATV’s), off road vehicles (ORV’s), and neighborhood electric vehicles (NEV’s), with a subsidiary company that produces motorcycles. The origin of what would become Polaris Industries started in the 1950’s. It began with Edgar Hetteen and business partner David Johnson. Edgar and David were partners in a business that specialized in building agricultural...
Words: 1567 - Pages: 7
...Apple had an impressive $147 billion in cash at the end of last quarter. Carl Icahn owns a nearly $2 billion stake in Apple that he wants the company to issue a $150 billion buyback of its stock, believe the company to be extremely undervalued, Icahn, who considers Cook a good CEO, projects Apple’s stock can rise to more than $625 if it buys back shares. The catalyst would be a significant reduction in the share count, boosting EPS. Assuming moderate earnings growth, Icahn thinks the stock could return to its all-time high near $700. Icahn also wants Apple to borrow $150 billion at a 3 percent interest rate to fund the purchases and avoid paying more taxes, the person added. As Apple’s stock has slumped more than 20 percent in the past year on investor concerns about a dearth of new hit products, the iPad maker has become more vulnerable to calls for change from activists such as Icahn and hedge-fund manager David Einhorn. Apple is already implementing a substantial capital return program -- which includes approximately $60 billion in share repurchases between 2013 and 2015 -- but Icahn wants an even bigger and faster buyback. Their main argument is that if Apple significantly increases its stock buyback that will crowd out investment in research and development and other initiatives to boost innovation. This would in turn cause Apple to fall behind competitors, leading to a collapse in profitability. Does corporate raider Carl Icahns ideas pose a threat to Apple...
Words: 287 - Pages: 2
...Subject: Memorandum- Cost of Capital and Capital Structure Date: I. Cost of Common Stock The cost of common stock estimated varied widely between the three methods used. Under the CAPM approach, UPS had the lowest cost because it has the lowest beta coefficient, according to Value Line. Conversely, AAWW had the highest cost of common stock because its beta coefficient is almost twice that of UPS. Under the DCF approach, UPS and AAWW were swapped with regard to having a higher cost of common stock. The factor that was primarily responsible for this swap was the dividend, because UPS pays a fairly large dividend and AAWW does not pay a dividend. Under the Bond Yield Risk Premium approach, AAWW could not be evaluated because it does not issue corporate bonds. This is most likely because AAWW defaulted on its bonds when it declared Chapter 11 bankruptcy in 2004. AAWW’s corporate bond rating is assumed to be a “B” based on the interest rates that it is paying on the rest of its debt. UPS is lower than FDX, which is reflective of UPS having a higher credit rating, which leads to a lower interest rate on its bonds. I would use the DCF approach because it reflects the dividend that is paid, which is a direct cost to the company. II. Cost of Preferred Stock None of the firms have preferred stock outstanding, so this section is inapplicable. III. Cost of Debt The cost of debt for the firms is strongly affected by the credit ratings of the...
Words: 2071 - Pages: 9
...needed to found a way to counteract profit loss and unhappy stock holders. The announcement that IBM would repurchase $2.5 billion of its own stock resulted in a price jump of 7% because "stock buybacks are a traditional way for corporations to return excess cash to shareholders without increasing quarterly dividend requirements. These payments are one-time cash distributions, over and above the normal cash dividend amounts, with the shares normally repurchased in open market transactions. In fact, in recent years, share repurchases have returned more cash to shareholders than cash dividends" (Hurtt, Kreuze, & Langsam, 2008). "Stock buybacks can increase stock prices on announcement, due to the anticipated reduction in the number of shares outstanding" creating a seller's market (Hurtt, Kreuze, & Langsam, 2008). for someone with a surplus of stocks in their hand, this is a favorable situation. "Companies often dispute this direct relationship. Intel, for example, spent approximately $4 billion on stock buybacks during 2004 and issued 63.7 million shares to employees due to the exercise of stock options. To counteract dilution from these options exercises, $641 million in cash outflows were required. Moreover, while Intel has repurchased 2.2 billion shares at a cost approximating $42 billion from 1990 to 2004, Intel had as many split-adjusted shares outstanding in 2004 as it did in 1990. Chuck Malloy, Intel’s communication head, said there is no connection...
Words: 325 - Pages: 2
