Read the following material over a company facing a critical decision. Conduct your own analysis of the firms options and develop a recommendation. Write a 2-3 page paper (double spaced, not including graphs or other exhibits) reporting your evaluation of the options and your recommendation.

You are a financial consultant who has been retained to analyze the status quo and the presented options and make a detailed recommendation to the Board. Your analysis should include an estimated share price, a discussion of retention and payout rate, and a comparison with the share price under status quo for both proposals. Your paper should be organized as a detailed professional proposal, with an executive summary and conclusions supported by data and analysis. Data and calculations should be attached in an appendix and work should be submitted in a separate spreadsheet.

The firm:

The Initech Company is a large manufacturer and distributor of electronic components. Despite being a major player in the industry the firm has failed to provide significant returns to its shareholders in recent history. Due to the economic downturn and because of some successful new products marketed to manufacturers of personal computers by a competitor, Initrode, the firm has recently undergone a period of slow but persistent growth. During this time the then CEO, in consultation with the Board, determined that earnings are best paid out as dividends.

Earnings in 2017 and 2018 were $1,068M and $1,132M respectively. The firm has 500M shares outstanding and currently employs a payout strategy of 75% in the form of dividends. 25% of earnings is retained to provide cash for potential use in future mergers or acquisitions and debt repayments. The equity cost of capital is 15%. The steady growth has continued and the firm had earnings of $1,200M in 2019 and must decide how to use these funds to improve shareholder value.

Indeed, the Board has received significant pressure from major shareholders to find ways to increase shareholder value. Many shareholders originally conceived of Initech as a growth firm with significant opportunities for share price appreciation, ideal for them as their high income level puts their marginal tax rate over the capital gains tax rate. However, recent stagnation, and a payout policy geared towards producing dividend income, has cost Initech this perception. This culminated in the ouster of the CEO and the installation of a new CEO. As a result, the Board has solicited input from R&D and the CFO to develop proposals to use earnings to increase shareholder value. The Board did provide guidance that a retention rate of 10%, or more, is necessary for their business strategy.

Proposals:

Growth opportunity:

The R & D team is excited to have been approached and has an exciting new product for potential development. They forecast that an investment of $699.6M would result in a return on the new investment of 23%. They also forecast that this new product will offer constant and ongoing growth at this rate. They note that the return on the new investment may be as low as 20% and as high as 25%.

Share Repurchase program:

The CFO has detailed a repurchase program in which the firm would payout $1,144.8M, $254.4 in share repurchases and the rest as dividends.