Question 1 Electronic Inc. has 750,000 shares of stock outstanding, total earnings of $6,000,000, a market price per share of $48, and pays a cash dividend of $2.0 per share. Recently the company has developed a new electronic product on computer motherboard which is more efficient. After investigating the possibility of manufacturing this new product, Electronic determined that the costs involved in building a new plant is very high. The management decided that they are unwilling to invest heavily on it; instead, they can sell the design to an outside firm. The sales of this design can earn an after- tax payment of $30 million. From the company perspective: A. As the financial director of Electronic Inc., will you recommend the company to 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? B. Do you recommend the company to use the extra cash to pay off debt? How will this proposal affect the company? C. One of the directors is suggesting 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? D. While the general manager also suggested to increase the regular dividend payment to shareholders. How would you evaluate this proposal? E. One way to value a share of stock is the dividend growth, or growing perpetuity model. Consider the following: The dividend payout ratio is 1 minus b, where b is the retention or plowback ratio. So the dividend next year will be the earnings next year El x (1-retention %). 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'll be able to calculate the price of a share today. 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. Prepare a report as the finance director of the company to address all issues above. Question 1 Electronic Inc. has 750,000 shares of stock outstanding, total earnings of $6,000,000, a market price per share of $48, and pays a cash dividend of $2.0 per share. Recently the company has developed a new electronic product on computer motherboard which is more efficient. After investigating the possibility of manufacturing this new product, Electronic determined that the costs involved in building a new plant is very high. The management decided that they are unwilling to invest heavily on it; instead, they can sell the design to an outside firm. The sales of this design can earn an after- tax payment of $30 million. From the company perspective: A. As the financial director of Electronic Inc., will you recommend the company to 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? B. Do you recommend the company to use the extra cash to pay off debt? How will this proposal affect the company? C. One of the directors is suggesting 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? D. While the general manager also suggested to increase the regular dividend payment to shareholders. How would you evaluate this proposal? E. One way to value a share of stock is the dividend growth, or growing perpetuity model. Consider the following: The dividend payout ratio is 1 minus b, where b is the retention or plowback ratio. So the dividend next year will be the earnings next year El x (1-retention %). 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'll be able to calculate the price of a share today. 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. Prepare a report as the finance director of the company to address all issues above
