Case Study on Electronic Timing Ltd

Question: Case study on Electronic Timing Ltd. Answer: Option 1:- Generally, special dividend is paid by the companies, if it earns any huge amount of profit or the balance sheet exhibits huge amount of cash or cash equivalents. Special dividend would surely make the shareholders happy. But it has many other consequences, which should be considered before taking decision for distribution of special dividend. Distribution of any kind of dividend causes huge amount of cash outflow. Therefore, it has been observed that the stock prices of the companies use to fall immediately after paying off any kind of dividends. On the other hand, due to the outflow of cash, the amounts of current assets, as well as, the total assets gets decreased, which causes fall in total value of the company to (Garcia Moore, 2012). The situation is described in the following table with imaginary figures:- Pre Distribution of Special Dividend Post Distribution of Special Dividend Particulars Amount Amount ($ in million) ($ in million) Total Assets 100 70 Total Liabilities 45 45 Net Value of the Company 55 25 Option 2:- If the selling amount is used for paying off the debts, then the amount of interest payable would become lesser. It would then increases the net earnings, which in return, can increase the amount of dividend payable. Moreover, by utilizing the amount for expansion of manufacturing capability, the company can increase the assets and its market value. It can also help to amplify the manufacturing capability of the company, which would lead to higher future earnings. Hence, this decision may prove to be beneficiary for both the company and its shareholders (Sarkees et al., 2014). The scenario is explained through imaginary figures in the following table:- Pre Expansion Payment of Debt Post Expansion Payment of Debt Particulars Amount Amount ($ in million) ($ in million) Total Assets 100 115 Total Liabilities 45 15 Net Value of the Company 55 100 Total Production Unit 15000 25000 Production Cost @$100 p.u. 1500000 2500000 Sale Price @$150 p.u. 2250000 3750000 Gross Profit 750000 1250000 Options 3:- Share repurchase is the process, followed by the companies to acquire its own shares from the market and reduce the volume of outstanding shares. It helps the company to increase the rate of return on assets and the return on equity by reducing the nos. of outstanding shares. But it does not increase P/E Ratio, it makes the Earning Per Share higher, which in turn, reduce the P/E Ratio. The Condition is shown below with imaginary figures:- Particulars Pre Share Repurchase Post Share Repurchase Outstanding Shares in Units 1000000 750000 Share Price $100 $100 Total Equity Capital $100,000,000 $75,000,000 Average Total Assets $150,000,000 $125,000,000 Net Earnings $5,000,000 $5,000,000 Earning Per Share $5 $7 P/E Ratio 20 15 Return on Assets 0.033 0.040 Return on Equity 0.05 0.07 But it has been observed that it carries more uncertainty than dividend payments over the long-run. The decision of share repurchase would be effective if the market price of shares remains constant or experience growth over the period. If the market price falls in due course of period, then such decision would cause unnecessary outflow of cash. Moreover, the positive effect of share repurchase can be enjoyed in long run. It is not suitable for instant rise in the value of the company (Hillert et al.,2016). Option 4:- The company can retain the additional income for paying dividends. In such scenario, the stock price of the company would also fall after distribution of dividends. However, many investors use to evaluate the companies in accordance to the dividend paid by it. They use to measure the financial performances of the companies by the rates of its dividends. Therefore, if the company uses to pay the additional income as normal dividends at high rate, the potential investors would feel that the company is performing very well and thus, would like to invest more in the company. It would ultimately help to increase the market price of the company. The consequences are explained in the following table:- Distibution of Dividend in Normal Rate Distibution of Dividend in Higher Rate Particulars Amount Amount ($ in million) ($ in million) Total Stock $100,000,000 $100,000,000 Net Income for Distribution $2,500,000 $32,500,000 Dividend Yield Rate 0.025 0.325 Option 5:- Dividend growth model or growth perpetuity model is one of the widely used model for evaluation of share stock prices. It uses to value the share price by assuming that there would be constant growth in the dividend payment over the consecutive periods. As stated in the question, the value of the stock is used to be measured on the basis of the dividend rate of the present year. Therefore, if the extra income is used for paying dividend at higher rate, then the dividend growth model will show higher value of the stock prices than the stock prices of other competitive companies. It will ultimately help the company to draw more investors within in a short period. The effect is shown in the following chart with imaginary figures:- Distribution of Dividend in Normal Rate Distribution of Dividend in Higher Rate Particulars Amount Amount ($ in million) ($ in million) Total Nos. of Shares 1000000 1000000 Total Equity $10,000,000 $10,000,000 Total Earnings $35,000,000 $35,000,000 Net Income for Distribution $2,500,000 $30,000,000 Required Rate of Return 0.60 4.50 Current Price of Stock 25 25 Current Annual Dividend 2.50 30.00 Retention Ratte 0.93 0.14 Dividend Payout Ratio 0.07 0.86 Return on Equity 3.5 3.5 Dividend Growth Rate 0.25 3.00 Fair Stock Value 26.79 85.00 On the hand, if the company will spent the amount for expansion of production capabilities, it can enjoy the higher earnings and pay higher rate of dividend but in long run. Moreover, the rise in income on the long run also depends on how effectively the company has utilized the expanded production system for generating higher income in future. Therefore, this decision will not create any affect on the outcomes of dividend growth model currently. Hence, it can be stated that if the company wants to attract more investors within a short span, they should utilize the additional income for paying off normal dividend instead of expansion of the business (McMillan, 2015). Reference List:- Garcia, M., Moore, C. M. T. (2012;2011;).The cash dividend: The rise of cash transfer programs in sub-saharan africa. US: World Bank Publications. doi:10.1596/978-0-8213-8897-6 Hillert, A., Maug, E., Obernberger, S. (2016). Stock repurchases and liquidity.Journal of Financial Economics,119(1), 186-209. doi:10.1016/j.jfineco.2015.08.009 McMillan, D. G. (2015). Time varying predictability for stock returns, dividend growth and consumption growth.International Journal of Finance Economics,20(4), 362-373. doi:10.1002/ijfe.1522 Sarkees, M., Hulland, J., Chatterjee, R. (2014). Investments in exploitation and exploration capabilities: Balance versus focus.