Question #1: Dividend Policy (Chapter 17)

DCAD Limited is a medium sized computer-aided designing and computer-aided equipment manufacturing firm. In recent years, the firm had been growing away from its traditional tools- and-molds business and into a new line of products integrating hardware and software to provide complete manufacturing systems.

In September 2014, Mike Klemen, the firms chief financial officer (CFO) needed to make a recommendation to the board of directors regarding the firms dividend payout policy, which had been the subject of an ongoing debate among the firms senior managers.

After years of traditionally strong earnings and predictable dividend growth, the company faltered in the past five years. In response, management implemented two extensive restructuring programs, both of which were accompanied by net losses. For three years in a row since 2009, dividends had exceeded earnings. Then, in 2012, dividends were decreased to a level below earnings. Despite of extraordinary losses in 2013, the board declared a small dividend. For the first two quarters of 2014, the board declared no dividend. But in a special letter to shareholders, the board committed itself to resuming payment of the dividends as soon as possible, ideally, sometime in 2014.

Overall, management view was that DCAD Limited was a resurgent company that demonstrated great potential for growth and profitability. The restructurings had revitalized the companys operation divisions. Many within the company viewed 2014 as the dawning of a new era, which, in spite of the companys recent performance, would turn it into a growth stock. One of the rating agencies has given the company an A rating.

A number of corporate objectives had grown out of the restructuring and recent technological advances. First and foremost, management wanted and expected the firm to grow at an average annual compound rate of 15%. A great deal of corporate planning had been devoted to that goal over the past few years and its most recent financial data suggested that the company was transitioning and expanding on the right path.

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The company had an aversion to debt since its inception. Management believed that small amounts of debt, primarily to meet working capital needs, had their place but anything beyond a 40% debt- to-equity ratio would not be acceptable. The companys highest debt-to-equity ratio in the past 30 year (25%) was to this day the subject of conversion among senior managers.

Mr. Klemen contemplated his choices from among the three possible dividend policies to decide which one he would recommend:

? Zero-dividend payout: This option could be justified in light of the companys continuing strategic emphasis on advanced technologies, and reflected the huge cash requirements of such a move.

? 50% dividend payout (a dividend of $0.20 per share): This option would restore the firm to an implied annual dividend payment of $0.80 a share, the highest since 2012. Proponents of this policy argued that such an announcement would be justified by expected increases in sales, and it would be suggest that the company had conquered its past problems and the senior management was confident of its future earnings.

? Residual dividend payout: A few members of the finance department argued that the company should pay dividends only after it had funded all the projects that offered positive NPVs. One argument raised in support of this view was that the particular dividend policy was irrelevant in a growing firm. This argument reflected the theory of dividends in a perfect market advanced by Merton Miller and Franco Modigliani.

Klemen was in a difficult position. Some board members and senior managers saw the company as entering a new stage of rapid growth and thought that a large dividend would be inappropriate. Others, however, thought that it was important to make a public gesture showing that management believed that the firm had turned the corner and was about to return to the levels of profitability seen some years ago.

[Question 1] Based on your knowledge and understanding of corporate dividend policy, discuss and evaluate the three alternative payout policies for DCAD Limited.