Gainesboro Corporation is a company that began in 1923 as a manufacturer of metal machinery parts which was in high demand during the Second World War. Since then, Gainesboro has changed with the times, entering into the machine tool industry in 1975 and most recently has transitioned into computer-aided design and computer-aided manufacturing (CAD/CAM) equipment manufacturer. Recently, two events have events have taken place which have further stressed the financial stability of the company; one being the Hurricane Katrina, which caused an 18% drop in Gainesboro’s stock, the other being two company-wide restructuring initiatives, which cost a total of $154 million. However, the latter comes with an upside: the development of a new and innovative product which the company believes will give them an advantage over their immediate competition. With Gainesboro’s financial strength in turmoil, CFO Ashley Swenson must submit a new dividend policy to the Board of Directors. She must decide whether more value will be added by paying shareholder dividends or to buy back company stock, the objective being to achieve a 15% compounded annual growth rate.
In order to create the most value for Gainesboro, Swenson must analyze what dividend policies will maximize share holders wealth while also minimizing the risk incurred by the company. Therefore, an analysis of the four following policies must be conducted. There are several implications of each policy which are described below. Zero dividend policy: this policy should be considered because the company is expecting high growth in the future and it would be in the best present interest of the company to preserve and retain cash rather than paying out in the form of dividends. This would ensure that Gainesboro’s debt ratio remains below the 40% while also allowing flexibility for future expansion and investments in R&D. However, this...