Gainesboro Case Study Solutions - Homemade Dividents

1. The proposed dividend policies all have both positive and negative aspects.

a. A zero-dividend policy would assist in supporting new high-tech endeavors (CAD/CAM machines) by preserving capital, as well as support sentiments of growth within the company. However, there is a possibility that value-oriented investors and those looking for steady cash flows will jump ship.

b. A 40% (approx. $. 20 dividend) payout policy would put the company in line with industry payout standards.

In addition, it would indicate internal confidence with regards to future earnings.

Unfortunately, this policy would absorb cash and possibly limit the availability of cash for future investments, especially since earnings in recent years have been sluggish, and a 15% growth rate may be considered overly optimistic.

c. A residual dividend policy removes the need for added debt, and pays dividends only after all projects with positive NPVs were financed. This policy has the potential to limit increased debt, improve growth, and build investor trust.

In contrast, dividends would be unpredictable, and decreases in successive dividends would put downward pressure on the share price.

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d. Share repurchasing would clearly instill confidence in the market by increasing EPS and share price, but would also require that Gainesboro carry more debt.

2. There are two major ways to create stock value. One is to increase share price over time, and the other is to pay constant, strong dividends. Paying a dividend would signal confidence for the future. It would also realign the company with industry payout standards.

However, investors with longer investment horizons should realize that a company retaining earnings is looking to reinvest capital and increase firm value, which consequently increases shareholder value.

3. I would be inclined to recommend against a 40% payout. Management is looking for growth and investment, not increased debt and constricted cash accounts. Paying this dividend would limit future investments by sucking up all excess cash. A growing firm, especially one investing in high-tech projects, should be reinvesting excess earnings.

Plus, should Gainesboro not meet the target growth of 15% continually, they may not be able to handle the proposed dividend policy. The zero-dividend policy looks attractive, especially since growth in high tech areas will require large cash investments. Strong jawboning and positive investor relations coupled with a zero-dividend policy would allow for growth. Should investors require immediate return, they could create homemade dividends. I would recommend a zero-dividend policy to avoid increased debt and allow for future investments. Positive investor relations and transparent operational policies will maintain a positive sentiment.