Question

ELECTRONIC TIMING, INC. Electronic Timing. Inc., (ETI) is a small company founded 15 years ago by electronics engineers Tom Miller and Jessica Kerr. ETI manufactures integrated circuits to capitalize on the complex mixed-signal design technology and has recently entered the market for frequency timing generators, or silicon timing devices, which provide the timing signals or “clocks” necessary to synchronize electronic systems. Its clock products originally were used in PC video graphics applications, but the market subsequently expanded to include motherboards, PC peripheral devices, and other digital consumer electronics, such as digital television boxes and game consoles. ETI also designs and markets custom application-specific integrated circuits (ASICs) for industrial customers. The ASIC’s design combines analog and digital, or mixed-signal, technology. In addition to Tom and Jessica, Nolan Pittman, who provided capital for the company, is the third primary owner. Each owns 25 percent of the one million shares outstanding. The company has several other individuals, including current employees, who own the remaining shares. Recently, the company designed a new computer motherboard. The company’s design is both more efficient and less expensive to manufacture, and the ETI design is expected to become standard in many personal computers. After investigating the possibility of manufacturing the new motherboard, ETI determined that the costs involved in building a new plant would be prohibitive. The owners also decided that they were unwilling to bring in another large outside owner. Instead, ETI sold the design to an outside firm. The sale of the motherboard design was completed for an aftertax payment of $30 million.

Tom believes the company should use the extra cash to pay a special one-time dividend. How will this proposal affect the stock price? How will it affect the value of the company?

Jessica believes that the company should use the extra cash to pay off debt and upgrade and expand its existing manufacturing capability. How would Jessica’s proposals affect the company?

Nolan is in favor of a share repurchase. He argues that a repurchase will increase the company’s PE ratio, return on assets, and return on equity. Are his arguments correct? How will a share repurchase affect the value of the company?

Another option discussed by Tom, Jessica, and Nolan would be to begin a regular dividend payment to shareholders. How would you evaluate this proposal?

One way to value a share of stock is the dividend growth, or growing perpetuity, model. Consider the following: The dividend payout ratio is one minus b, where b is the “retention” or “plowback” ratio. So, the dividend next year will be the earnings next year, E1, times one minus the retention ratio. The most commonly used equation to calculate the sustainable growth rate is the return on equity times the retention ratio. Substituting these relationships into the dividend growth model, we get the following equation to calculate the price of a share of stock today: Images What are the implications of this result in terms of whether the company should pay a dividend or upgrade and expand its manufacturing capability? Explain. Does the question of whether the company should pay a dividend depend on whether the company is organized as a corporation or an LLC?

Answer 1

Answer - 1

Special dividend will increase the share price before the Ex-dividend date. But after declaration of dividend, the Share price will fall by the amount of Special dividend or more than the amount of special dividend in some cases. The value of the will also decline as we pay the special dividend, the reserves will be reduced and it will leads to reduction in the value of the company.

Answer - 2

Jessica's Proposal to Pay off Debt sounds good as this will reduce the interest burden of the company and also increase the productivity of the company, provided if the manufacturing facility is expanded and upgraded, earnings availability of the shareholders and ultimately market price of the company. Thus it would be an option of better use of cash.

Answer - 3

The repurchase should be equivalent to the issuance of cash dividend with the same amount as regards to the effect on shareholders wealth. Thus the way the share repurchases is done, it does not create or diminish shareholders wealth, because repurchase neither increase or decrease the shareholders value. The effect is decrease in both assets and shareholders’ equity.

Hence the Nolan’s argument that the company’s return assets and the return on equity will increase the P/E ratio of the company is not correct. The P/E ratio may increase until the market corrects its share price.

Answer - 4

A plan to issue regular dividend is a start in a dividend payout policy plan. Regular dividend payments is also a good option as dividend growth will have positive effect on the share price of the company and will increase the value of the enterprise. It will also not have full cash outflow at one go. Payment of regular dividend creates a continuing liability to the company. Any default in the payment of dividend may lead to a decrease in the share price of the company.

Answer – 5

In case of Dividend growth Model the Dividend Payout ratio will increase the share price whereas in case of up gradation or expansion the price will remain more or less same. To attain the companies targeted rate of return for upgrading and expanding its manufacturing plant rather using it for cash dividends, the firm should retain the more of its earnings in the company.

Answer - 6

The Payment of dividend is based on the fact that the company is organized as a corporation or an LLC. A company is a corporation and he can declare and pay the dividend to its shareholders. whereas in case of Limited Liability Company members do not have the right to receive any dividend. However the members of LLC may receive distribution of profit from the discretion of the management or as required in the operating agreement.

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