Fuelem, Inc.

An exercise in dividend policy.

Fuelem, Inc. (Fuelem) is a company that was founded about 15 years ago by NEIU graduates Lisa Rentas and Mark Freeman. The company manufactures hydrogen fuel cells which are used to provide a backup energy source for hospitals and schools. The company has a patent on the technology. In addition to the founding partners, a fellow NEIU graduate named Robert Devereaux, now working for the firm of Dewey Cheatem and Howe, also provided seed money to start up the company. Each of the three principles owns 25% of the one million shares outstanding. Current employees own the residual 25% of the outstanding stock.

Recently, the company found that it could re-engineer its fuel cell to make it less expensive and more efficient. After investigating the feasibility of the requisite change in re-tooling their manufacturing process, the owners decided that the cost would be prohibitively expensive. Since the principles were unwilling to being in another large investor, the company sold the design and manufacturing rights to the new re-engineered fuel cell to an outside private equity firm, whilst retaining their original fuel cell business. Fuelem received a one-time, after-tax payment of $30 million for the new business.

1. Lisa believes that the company should use the sale proceeds to pay a special onetime dividend. How will this extraordinary dividend affect the value of the company?

2. Mark thinks that the company should use the extra cash to pay off debt and upgrade/expand its existing manufacturing capabilities. How would Marks recommendation affect the company?

3. Robert favors a share repurchase program. He says that the repurchase program would enhance the companys PE ratio, ROA, and ROE. Are his arguments correct? What would be the effect on the companys value?

4. The three principles also talked about the option of initiating a regular dividend payment to all shareholders. How would you critique this proposal?

5. One means by which to evaluate a share of stock is the dividend growth model. So, next years total dividend would be E * (1 - b), where b is the retention rate. One way to compute the sustainable growth rate is ROE times the retention ratio. Substituting into the div growth model, we get the following equation to calculate the price of a share of stock today:

P = E (1 b) / (R ROE * b)

What are the implications of this result in terms of whether the company should pay a dividend or upgrade/expand its manufacturing capability? Explain.

6. Does the question of whether the company should pay a dividend to depend on whether the company is organized as a corporation or an LLC?

Please answer with details and a proper explanation and calculation.