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GainesBoro Case

Dividend Policy
12-Apr-12 [Type the company name]

Group 2

GAINESBORO Gainesboro Case Analysis Conventional industry: Machine tools manufacturing Historically strong earnings and regular dividends 25% of revenue New industry: CAD/CAM software industry Expensive restructuring Enormous growth potential, in domestic and international markets The issue faced by the company Two expensive realignments $61.3 million loss in 2002 $140 million loss in 2004 Still paid $.25 / share dividend Share price down 24% from one year ago Avg$29.15 in 2004, currently Company Dividend Histroy For three years in a row since 2000, dividends had exceeded earnings In 2003, dividends were decreased to a level below earnings Despite losses in 2004, small dividend was declared It has not paid dividend in 2005 although it had committed earlier to pay sometime in 2005 For three years in a row since 2000, dividends had exceeded earnings In 2003, dividends were decreased to a level below earnings Despite losses in 2004, small dividend was declared It has not paid dividend in 2005 although it had committed earlier to pay sometime in 2005

Factors Influencing the Dividend policy Decisions There are three main factors that may influence a firm's dividend decision: Free-cash flow Dividend clienteles Information signalling

The Free cash flow theory The firm pays out, as dividends, any cash that is surplus after it invests in all available positive net present value projects. It does not explain the observed dividend policies of real-world companies Most companies pay relatively consistent dividends from one year to the next and managers tend to prefer to pay a steadily increasing dividend rather than paying a dividend that fluctuates dramatically from one year to the next

Dividend Clienteles A particular pattern of dividend payments may suit one type of stock holder more than another A retiree may prefer to invest in a firm that provides a consistently high dividend yield, whereas a person with a high income from employment may prefer to avoid dividends due to their high marginal tax rate on income

A key criticism of the idea of dividend clienteles is that investors do not need to rely upon the firm to provide the pattern of cash flows that they desire. An investor who would like to receive some cash from their investment always has the option of selling a portion of their holding Information Signalling Stock prices tend to increase when an increase in dividends is announced and tend to decrease when a decrease or omission is announced Managers have more information than investors about the firm, and such information may inform their dividend decisions, which is considered as an indication of firms health As managers tend to avoid sending a negative signal to the market about the future prospects of their firm, this also tends to lead to a dividend policy of a steady, gradually increasing payment.

What happens to Gainesboros financing need and unused debt 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?

Zero Dividend Pros Zero Dividend Cons

Its a growing company and needs the plough back the retained earnings Borrowing for dividend can be avoided Can be positioned as high growth and high technology firms More and more companies are not paying dividends Cash flow will be positive by 2007

Commitment Value oriented investors(13%), Long-term retirement people(26%) they need dividends DPS fallen from 1.03 to near zero Stock brokers have a negative sentiments

40% Dividend pros 40% Dividend Cons

Inline with expectation 0.8$/share , the highest since 2001 Show positive sign of confidence Inline with growth Will stay within the 40% debt/equity ratio Will increase by 10%( a total of ~ 20%)

Unnecessary increase in debt Growth company needs to plough back 15% growth is too optimistic Positive cash flow will be happen only in 2011, else in 2007 itself! Even with a 15% growth If the growth is 10%

Residual Dividend Payout


Pros Giving back only excess retained earnings Cons Dividend may not be constant The companys image might be hampered

Repurchase Pros Will instill confidence In turn increase the share price Increase EPS Reduce the dilution Cons As of now they have to take debt to buy back shares

Image makeover Pros Will increase the brand awareness Might increase share price Long term intangible asset Cons Is it required now ? Its not proven, its speculative High cost

Suggestions and Recommendations Need to restore confidence and need to be growth oriented They need to pay dividend or repurchase of stock Paying dividend is better

With 40% the cash flow will become positive only in 2011 But with 30% it will happen in 2009 itself! Its also safe(10% -20% growth should accompany a dividend of 30%-50%) Its in sync with the industry average

Conclusion

Corporate debt and dividend policies emerge after weighing difficult trade-offs among competing desirable ends. No algorithm or model straightforwardly dictates policies. As analysts and managers, we confront the need to run the decision process well by ensuring that all trade-offs surface and that all arguments are heard. Ultimately, good policies meet these three tests:

1. Do they create value? 2. Do they create a competitive advantage? 3. Do they sustain the companys managerial vision?

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