Gainesboro Case

In theory, to fund an increased dividend payout or a stock buyback, a firm might invest less, borrow more, or issue more stock. Which of those three elements is Gainesboro’s management willing to vary, and which elements remain fixed as a matter of the company’s policy?

Gainesboro gives very high priority to pay dividends to its shareholders, which is quite evident from the firm paying dividends despite heavy losses in 2004 and its letter to the shareholders that it will resume dividend payments in 2005. Gainesboro is debt averse since its inception. Management tries to maintain 40% debt-to-equity ratio and its highest debt-to-capital ratio was 22% in 2004. Therefore, of the three elements - invest less, borrow more or issue more stock, Gainesboro is the least flexible about borrowing more. Because the company wants to invest and expand rapidly in the CAD/CAM sector and is also trying to reposition itself as technology company it has to invest and cannot vary about that. To fund its investments to expand its CAD/CAM offerings on the cutting edge of the industrial technology, to rebrand as a technology firm, to fund its acquisitions and joint ventures and expand internationally while maintaining low debt-to-equity levels Gainesboro could consider issuing more stocks as Gainesboro favors capital financing to debt financing.

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 board of directors with regard to a long-term dividend payout policy for Gainesboro Machine Tools Corporation?

Each of the three options have their own potential advantages and disadvantages based on the growth stage of the firm and investors perspective i.e, if it is income seeking investor or capital gains investor or creditor. Generally firms that are...