Dividend Policy Case (Gainesboro Machine Tools)-Session 2-Group 8

Gainesboro Machine Tools Corporation

Agenda • Introduction – Company background • Dividend payment decisions • Policy analysis – Zero dividend payout – pros and cons – 40% or $0.2 per share – pros and cons – Residual-dividend payout – pros and cons

• Conclusion

Company background • Founded in 1923 • In early days, it has designed and manufactured a number of machinery parts, including metal presses, dies and molds. By 1975, it has evolved as innovative producer of industrial machinery and machine tools. • In 1980, entered in CAD/CAM and established itself as industry leader • Aggressive entry of large foreign firms damped sales • The recent restructuring has improved efficiency and development of Artificial Workforce. System. • The company is expected to have good growth in future

Dividend history • 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

Dividend payment decisions • Dividends is considered as a yardstick of a company's prospects • Typically, mature, profitable companies pay dividends • If a company with a history of consistently rising dividend payments suddenly cuts its payments, investors should treat this as a signal that trouble is looming • Steady or increasing dividends is certainly reassuring, investors are wary of companies that rely on borrowings to finance those payments • Holding onto profits might lead to excessive executive compensation, sloppy management, and unproductive use of assets

Factors influencing dividend decisions There are three main factors that may influence a

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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 realworld 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 firm’s 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.

Zero dividend • Pros – It’s 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

Zero dividend • Cons – Commitment! – Value oriented investors(13%), Longterm retirement people(26%) • they need dividends

– DPS fallen from 1.03 to near zero • Stock brokers have a negative sentiments

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40 percent dividend • Pro’s – 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%)

40 percent dividend • Con’s – 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% Projection 2005 2006 2007 2008 2009 2010 2011 – $ (30.4) $ (25.3) $ (23.1) $ s $ (18.1) $ (25.7) $ (12.0) Excess (24.7) –

Residual dividend payout 

• Pro’s – Giving back only excess retained earnings

• Con’s – Dividend may not be constant • The company’s image might be hampered

Repurchase • Pro’s – Will instill confidence • In turn increase the share price

– Increase EPS – Reduce the dilution

• Con’s – As of now they have to take debt to buy back shares  

Corporate image advertising • Pro’s – Will increase the brand awareness – Might increase share price – Long term intangible asset

• Con’s – Is it required now ? – Its not proven, its speculative – High cost

Suggestion • 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

• Thank You  

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