Gainesboro Machine Tools Corporation

Case #25

Gainesboro Machine Tools Corporation

Objectives

In September 2005, Chief Financial Officer (CFO) Ashley Swenson, of a computer -aided design and computer-aided manufacturing (CAD/CAM) equipment manufacturing company had to make the decision of paying out dividends to shareholders, or to repurchase stock. If Swenson went with the option of the payout she would need to decide on how large the payout would be. Another issue Swenson had to face was to decide rather the company should take on the campaign of corporate-image advertising, and convert its corporate name to mirror its new outlook. The case serves as a review of the many practical aspects of the dividend and share buyback decisions, to include signaling effects, clientele effects and the finance and investment implications of increasing dividend payouts and share repurchase decisions. This case can follow a treatment of the Miller-Modigliani dividend-irrelevance theorem and serves to highlight practical considerations to consider when setting a firm's dividend policy.

Company Background

Gainesboro Corporation was founded in 1923 in New Hampshire. The founders of the company were two mechanical engineers, James Gaines and David Scarboro. The company by 1975 had made a name as an innovative producer of industrial machinery and machine tools. The company perfected CAM equipment by developing a line of presses that manufactured metal parts by responding to computer demands. The company also developed a superior line of CAD software and equipment that allowed engineers to design a part to exact specifications on a computer. The company innovated the market by providing a superior product. This was proved by the company's sales, profit and growth throughout the 90's and early 2000's.

The company fell behind its competition in the development of software and as a result the company's revenues suffered dropping from $911 million in 1998 to $757 million in 2004. As a result the company had to undergo restructuring once in 2002 and another later in 2004 costing Gainesboro a combined total of $202 million. At the end of restructuring the company had become much leaner and was able to develop software in which it believed would give it the position that was needed to take control of their market. Yet, there was still the gloomy fact that the company suffered a drastic reduction in the cost of its dividend to$ .25 a share. The company had decided in 2005 that it would not pay a dividend until they had a reached a period of fiscal responsibility.

Suggested Questions

1. In theory, to fund an increased dividend payout or a stock buyback, a firm might invest less, borrow more, or issue more stock. Which of those three elements is Gainesboro's management willing