Eastboro Machine Tools Corporation

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STATEMENT OF THE PROBLEM

Although this case presents several different issues to consider, the underlying problem is the correct implementation of Eastboro's dividend policy. Eastboro was founded as a manufacturer of machine parts, and has traditionally paid a fairly substantial dividend. However, in recent years, the core focus of the company has shifted toward technology in the fields of computer-aided design and manufacturing, highlighted by its latest development, Artificial Workforce.

This shift in the focus of Eastboro has brought about some financial changes as well. With revenues falling, they have missed two quarters' worth of dividend payments, and have promised to try to begin repayment of them by the end of 2001. However, to do this, they may need to borrow money, not only in 2001, but in the next several years. Eastboro has always been debt averse, so this is an unsettling prospect for them. There are several options being discussed, such as a zero-dividend payout, a 40% payout, and a residual payout policy. This major issue, as well as what direction the firm is going, and whether that corresponds to the wishes of current shareholders are the main issues needing to be addressed by Ms. Campbell.

FACTS

Current dividend policy = 40%

Attacks on World Trade Center and Pentagon occurred one week prior

Stock has fallen 18% since attacks

Firm has committed itself to resuming dividend payout, presumably in 2001

Potential name change to Eastboro Advanced Systems International, Inc.

Rated as an "A" company by Value Line

Recent decline in net revenues and profit margins

Future international growth is expected

Involved in high cyclical environment

GDP expected to fall from 4% to 1.6%

Largest % of individual investors are focused on retirement needs

Largest % of institutional investors are value-oriented

Management expects growth of 15%

CAD/CAM and cutting edge technological products will account for 75% of sales in future

Expansion through joint ventures and acquisitions of small software companies

Management places "Interests public of shareholders first"

Chairman seeks to maximize growth in market value of Eastboro's stock in future

ASSUMPTIONS

Name change to Eastboro Advanced Systems International changes image positively

Core focus shift toward research and development of CAD/CAM products will continue

International growth will become a focus of the company

Growth rate of 15% is applicable

Investors with long-term focus will remain with company even after the changes are implemented

We will pay a dividend in the future

We assume a hybrid dividend policy to be most effective in shareholder maximization

Managers are focusing on maximization of shareholder value

ANALYSIS

Our main concern with Eastboro is their current dividend policy. With their current 40% dividend payout ratio, they will have to continue to borrow money to pay their dividend until the end of 2006. In 2007, they finally see an excess of cash after the dividend. With this current ratio, Eastboro's hope to expand more in the international market is very restrained. Since management does not like to take on debt, they theoretically won't expand until 2007. However, with the recent restructuring of the company and recommendation of a name change, we feel that the dividend policy needs a make-over, as well. Management wants to focus their energy to moving the image of the company to more of a growth company as opposed to a high dividend paying mature company. To obtain this image, the dividend payout ratio needs to be lowered drastically to a payout ratio of 10%. With this decrease in the payout, the new Eastboro Advanced Systems International (EASI) will convince shareholders of their change to a growth company. Switching to a 10% payout ratio allows Eastboro to see excess cash by 2004, rather than 2007 with the current ratio, giving them the ability to fund the...
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