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Background:

Payout structure refers to the way a corporation distributes free cash flow to shareholders, either through dividends or repurchases. Each form has its benefits and drawbacks and firm managers attempt to find the perfect payout policy in terms of risk / reward payoff for shareholders.

Objective:

To explore the financial effects of payout policy on:

 signalling effect;

 clientele effect; and

 the financial and investment implications of dividend and share repurchase decisions.

Task:

In mid-September 2005, Ashley Swenson, CFO of Gainesboro – a large computer-aided design and manufacturing (CAD/CAM) equipment maker, was considering paying out the firm’s shareholders through dividends or repurchasing shares.

It is your task to analyse and report whether she should pay out dividends or repurchase shares (or none). If yes, you need to justify the frequency and the optimal amount of the payout. Your response should cover (but not limited to) the following questions:

1. What is the main problem Gainesboro faces? Specifically, what is the purpose of a payout policy?

2. What happens to Gainesboro’s financing need and unused debt capacity if:

• no dividends are paid?

• a 20% payout is pursued?

• a 40% payout is pursued?

• a residual payout policy is pursued?

3. How might Gainesboro’s various providers of capital (shareholders and creditors) react if Gainesboro declared a dividend in 2005? What are the arguments for and against the zero payout, 40% payout, and residual payout policies?

4. How might various providers of capital (shareholders and creditors) react if Gainesboro repurchased its shares? Should Gainesboro do so?

Length:

Max 1000 words, excluding figures/tables/references.