Case study 2: Flatbush Shipyards, Inc.
Flatbush Shipyards, Inc. has just received a substantial increase in backlog orders from the U.S. Navy. In relation, some issues arise concerning an alteration of the current dividend rate.
The current EPS of the company is now $14-$15. Historically, the dividend payout ratio mounts to an average 50%. So, the company expects payout the payout in 1959 to be $7/share. In the previous year the dividend rate was cut from $1.3 to $1.2 per share. But after the new deal, the CEO proposed a hike in the quarterly payout to $1.6 per share from the $1.2 given at present. The CEO even suggested the dividend rate to be propped up to $1.80 in 1960.
One thing to mind is that the company’s share price is marked high volatility. Davis, the Chief Financial Officer, associated the fluctuations with speculative trading. He argued that the variability in dividend payouts contributes substantially in fuelling the speculation. Therefore, Davis is not in favour of the CEO’s dividend policy proposal. He thus suggested a radical change in dividend policy by paying a constant dividend of $1.20, while putting excess cash into a reserve. This measure will help stabilize the stock price by dampening the uncertainty in dividend payouts.
However, Davis’ proposal has received resistance from a number of company officials because: 1.
No other firm had adopted a similar dividend policy. Mr Davis’ proposal could not be tested in advance. 2.
Objections of shareholders are not taken into account.
The opportunity cost of maintaining the reserve is high (assuming it is invested in government bonds). 4.
Flatbush is a cyclical company. Changing the dividend policy could alter the composition of the clienteles. 5.
The maintaining of the $1.2 dividend level in May alone precipitated a decrease of almost 12% within 2 weeks.
Below are some characteristics of the company:
Characterised by high volatility (depending on war); e.g. $52.6 mill in 1944 to $12.7 mill in 1947. Sources of income: -
Two thirds from: small – medium sized navy vessels.
Twenty percent from the maintenance of the US Navy fleet. -
Other sources: orders (not more than 10 million in bad times).
Very conservative, there are no long-term debt outstanding as of 1958.
The estimated sale in 1959 mounts to $72 million. However, the company has backlog orders of up to $190 million to ensure a sale of $84 million in 1960. Statistical analyis:
Graph 1. Flatbush Shipyards, Inc; Share price and earnings (normalized to zero mean and one standard deviation).
Correlation factor: 0.70
Graph 2. Flatbush Shipyards, Inc; Share price and dividends (normalized to zero mean and one standard deviation).
Correlation factor: 0.83
Question Number One
We can find two comments regarding Mr Padgett’s proposals.
His proposal may be considered as a policy in line with the past, as far as dividends are concerned, this means, maintain their pay out ratio at a level of 50%. We can consider this as a stable dividend policy, although, it has a different effect of maintaining the level of dividends through years on the share prices.
Another consideration that we can make is that this sector is very cyclical; therefore we believe that trying to maintain the pay out ratio may not be a very wise decision, because this may have a very high effect on the share price.
About Mr David’s opinion we found some considerations to do.
He has a great concern in the share price fluctuation, so he recommends a different kind of policy. His proposal is to stabilise the level of dividends, not the pay out ratio, because he considers that this will affect the share price in a positive way.
His aim is to transform the stock into a growth stock, however, we don’t really think that this is possible because they are working in a very cyclical business, they are to...
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