Questions for Case 26
What are the problems here, and what do you recommend?
What happens to Gainesboro’s financing need and unused debt capacity if: a.
no dividends are paid?
a 20% payout is pursued?
a 40% payout is pursued?
a residual payout policy is pursued?
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. In addition, please check TN_26 provided in blackboard which will help you verify this question. Pays no dividends – If it pays no dividends, then Gainesboro would be able to channel all its earnings to fund its growth strategy. Its unused debt capacity would be channelled towards the high cash requirements of the firm’s strategic emphasis on advanced technologies and CAD/CAM.
20% - With a 20% payout ratio, the firm would have positive excess cash from 2009 instead positive excess cash from 2011 with a 40% payout ratio. This will enable the firm to use its excess debt capacity to fund its expansion needs, keeping within the debt-equity ratio of 40%.
40% - With a 40% payout ratio, the projections of 2005 would leave the debt equity ratio at 35%, which still gives the firm some debt capacity, albeit very little flexibility if it wants to keep within the 40% debt equity ratio. Perhaps the firm would have to exceed this threshold to meet its strategic growth needs, and seek more financing.
Residual dividend – The financing requirements would be less than that of the 20% and 40% payout, as dividends are paid only after Gainesboro has funded all the projects that offered positive net present values.
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...
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