This is a fictious case based on real world situations. Although the primary focus is the dividend policy decision the situation of the company has been influenced by its corporate strategy and this case offers the opportunity to also consider the behavioural, management, and general business issues. The case questions are:
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As a background to the dividend policy decision briefly evaluate the corporate strategy of Eastboro Machine Tools Corporation. What implications has this strategy had in the run-up to their current situation and what implications does it hold for the future. 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? What happens to Gainesboro’s financing need and unused debt capacity if: No dividends are paid?
A 20% payout is pursued?
A 40% payout is pursued?
A residual payout policy is pursued?
There is a Microsoft Excel template for students to use that has been placed on Vula. 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. 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 a long-term dividend payout policy for Gainesboro Machine Tools Corporation? How might various providers of capital, such as stockholders and creditors, react if Gainesboro repurchased its shares? Should Gainesboro do so? Should Swenson recommend the corporate-image advertising campaign and corporate name change to the Gainesboro’s directors?