Options for Funding Dividend Payout or Stock Buyback - Advanced Corporate Finance

This study analyzes the best option for Eastboro to fund an increased dividend payout or a stock buyback. It examines the financial structure and unused debt capacity of Eastboro and explores the response of capital providers. Recommendations are made for a corporate-image advertising campaign and corporate name change.

Advanced Corporate Finance

Table of Contents
Introduction......................................................................................................................................3
Question 1........................................................................................................................................3
Question 2........................................................................................................................................5
Part A...........................................................................................................................................5
Part B...........................................................................................................................................5
Part C...........................................................................................................................................6
Part D...........................................................................................................................................6
Question 3........................................................................................................................................7
Question 4........................................................................................................................................9
Question 5......................................................................................................................................10
Conclusion.....................................................................................................................................12
References......................................................................................................................................13

INTRODUCTION
The present study is based on the critical assessment of the best option for Eastboro to fund an
increased dividend payout or a stock buyback. Further, discussion has also been made relating to
the financial structure of Eastboro and its unused debt capacity if it pursues a 20 percent payout,
or a 40 percent payout, or a residual payout policy or make no payments of dividend. The study
also covers the response of capital providers, if dividend in 2001 is declared by Eastboro and in
case the company repurchases share. On the basis of analysis, the study will also draw
recommendations corporate-image advertising campaign and corporate name change to the
directors.
QUESTION 1
It is evidenced that Gainesboro, in terms of company priority willing to enhance per share value
to shareholders. The goal of company is to make payment dividend (emphasized in the study and
in the letter of Gaineboro to shareholders implying to resume the payout of dividend in 2005).
On more issues that is obvious about Gainesboro is that the culture of organization is creating an
adverse impact to debt. Unluckily, the cap the company has forced is 40 percent, i.e. the debt to
equity ratio will not be able to surpass this percentage. In the year 2004, funds were borrowed by
the company on an external basis for the payment of dividend, by this the level of debt increased
to 22% and the case highlighted that it was a problem that is put into discussion often in the
corporate meeting and still it is a major issue between the senior executives of company.
Shedding light to the sensitivity to debt of company, it is believed as an unlikely funding source
to finance the 2005 dividend promised by them. Yet, the promised 2005 dividend does not imply

that the stock buyback is not put into question or is not considered. On the other hand, all options
need an extra funding source. In accordance with the What Do We Know about Stock
Repurchases article, it has been stated by financial economists that managerial authorities of
company makes use of repurchases to indicate their optimism regarding the prospects of firm to
the marketplace (Bendig and et.al, 2018).
In the present case scenario, the management tends to vary their investment i.e. less investment
and issue of more stock, and the same does not contravene their policy, however the
management would not be prepared to consider more borrowing, it is because their policy of
borrowing is restricted to 40% debt to equity ratio.
Assessment of decision of Eastboro
(Amount in $)
Year 1999 2000 2001 (Projected)
Sales 815979 756638 870000
Profit Ratio 12993/815979 (140784)/756638 18018/870000
0.015 -0.18 .0207
Debt Equity Ratio 9000/401172 8775/282541 30021/300126
0.022 0.031 0.1
Investment
(Net property, plant
and Equipment)
160190 175355 205530

It can be accessed from above figures that company is having fluctuative trend in profit as no
similar trend could be asserted. Further, it can be concluded that issue of equity would be most
appropriate as it would be compliance with their policy relating to more investment and less
borrowing. The fluctuative profit of the company represent that the company is presently in not a
situation to take more borrowing. Further it can also be accessed that company is making
adequate investment in net property and plant but proportionately impact cannot be seen in sales
figures. Thus, the same eventually effect on the profitability of the company. Overall, it can be
concluded that it is more appropriate for the company to issue shares. As specified option will
provide liquidity through which adequate investment can be made in new profitable venture.
QUESTION 2
Part A
In a situation where there is no payment of dividends, the company does not require financing
for their dividends (Attig etal 2016). Thus, it can be stated that the financial needs for the
company will decrease. If the company makes payment of dividend at 40$, then they would be
required to consider borrowing in the year 2001 for $30 million and if there is no payment of
dividend, then mere borrowing of $23 million will be needed. Thereof, there is also increment in
the unused debt capacity if there is no payment of dividend.
Part B
In case, the company is in pursuit of 20% dividend payout policy, then the amount required for
the dividend will be calculated as $3.6 million against $7 million (with the 40% payout). In this
sense, lower financing will be needed by company, thereby decreasing its financing needs as
against of 40% dividend payout. In addition, there would be also decrease in unused debt

capacity, as the company is required to borrow a total of $26.6 million in against of $30 million
(with a 40% payout).
Part C
In a situation where, the 40% dividend policy is followed, then the corporate financing would
rise up, and the total funds needed to pay out dividends would be estimated as $7 million.
Moreover, the unused debt capacity will also tend to decrease, as the requirement of borrowing
will be subjected to approx $30 million.
Part D
Residual dividend is the dividend policy applied by the company for computing the dividend to
shareholders. In this dividend policy, the company finance its capital expenditure before
computing the earnings available to its shareholders (Koo, Ramalingegowda and Yu, 2017). In
this method, the company gives first preference to applied earnings on the capital expenditures
and then remaining earning available for the distribution to the shareholders (He etal. 2017).
Eastboro, in pursuit of the residual payout policy will require huge cash to adopt the strategies of
expanding in international market and considering acquisitions. However, this policy is
considered as a convenient alternative, and it is obliged to form considerable signalling issues as
the firms dividends are undergoing alternate decrease and increase through every economic cycle
(Caliskan, and Doukas, 2015). If the company use residual dividend payout policy, then
company should pay dividend only after funding all projects which generates positive net present
value. This policy is better policy, as because the investors provided funds to the manager for
investing in the projects, than can generate positive or more returns (Buchanan & et.al 2017).
With regards to it, it can be said that instated of giving unused funds to the shareholders in the
form of dividend, it is better for the company to deploy these funds in the project by which

company can generate more return and shareholders will be rewarded with higher valuation on
their investment (Esqueda, 2016).
Analysis of four scenarios:
Particular Analysis
No Dividend It can be assessed that overall financial needs for the company will decrease.
In case the company makes payment of dividend at 40$, then they would be
required to consider borrowing in the year 2001 for $30 million. Else
borrowing of $23 million will be needed
20% Payout The decision will eventually decrease unused debt capacity, as the company is
required to borrow a total of $26.6 million in against of $30 million. The
reason behind same is that the required amount of payment is is $3.6 million
against $7 million
40% Payout Enhanced payment relating to dividend will eventually lead to increase the
financial necessity of the company. It will also decrease the unused capacity as
the requirement of borrowing will be subjected to approx $30 million.
Residual Payout In the company applies residual dividend payout policy then company
requires to pay dividend only after funding all projects which generates
positive net present value. It can be concluded that it is most appropriate in
comparison to other options specified above.

QUESTION 3
In a situation where, dividend has been announced by the company in the year 2001, then it be
forced to take on more debt to raise money needed for the dividend. Similarly, the creditors
would not provide positive response with the ultimate decisions, as the money is not utilized in
the rising corporate value (Kumar and et.al, 2017). However, a positive response would be
placed by the stockholder because the dividend policy of company shows managerial confidence
in the company’s future earnings and it also provides better flexibility to stockholder to make
investment in their dividend earnings in any other company (Sáez and Gutiérrez, 2015).Further,
as a rational investor, everyone wants to invest in that company, in which they get more returns.
Residual dividend policy: On the basis of above information, it is apparent that Eastboro has not
facing any financial problems lately, because of its lower leverage policy, planned growth and
better earnings, of 15%, and it can be argued that currently residual dividend policy canbe highly
beneficial for the company at this stage. In this policy, the company use its earnings for the
capital expenditure, before distribution of the dividend to its shareholders (Koussis, Martzoukos,
and Trigeorgis, 2017). This will assist the company in making more investment in the
appropriate projects, which have positive net present value, with no more leverage, and on the
basis of projected growth, the company can pay dividends later on, when it has optimum amount
of resources (Erkan, Fainshmidt, and Judge, 2016). In other words, it can be said that, by residual
dividend policy, company can generate more profit by investing in the good projects and
ultimately it leads to increase in the wealth of the shareholders of company (Boumosleh, and
Cline, 2015).
Zero payment- By considering the requirement and interest of company on advanced
technologies and CAD/CAM, the justification of this option can be made. Although, this could

need immense amount of cash and would shed light on the fact that firm belongs to the category
of a one of the highest growth and technological firms. The argument against this option can be
that the company has been making payment of dividend for several years and this can come up
with confidence loss in the future prospectus and earnings of company (Ben‐Nasr, 2015). it will
also leads to negative impact on the company along with the reduction in the market price of the
shares (Jiraporn, Leelalai, and Tong, 2016).
40 percent payout: While, considering this option, this will provide an indication to the
shareholders and market that the firm has overcome with the problems and its confidence
towards the future earnings. Further, borrowing for the payment of dividend is also not very
inconsistent with the behaviour of many firms. Dividend provide the consistent income to the
shareholders and indirectly it helps the company as the confidence among the investor will rise
by obtaining the return and they wants to more invest in the company (Huang, and Paul, 2017).
On the basis of the growth strategy of Eastboro, Jennifer Campbell should recommend to pay the
promised dividends to the investors, while implementing a 40% dividend policy, as by this firm
would began to repay the dividends as it has assured to its investors. Along with this, this can
stimulate the market confidence back and lead to an affirmative increase in the prices of share.
Thus, the company should make investment to attain its goal of growth and when the company
reaches at the maturity stage them it should began to pay out the dividends (Adnan, Jan, and
Sharif, 2015).
QUESTION 4
Buying back of share, is definitely not a good option for company at this point, it is because it
signals of lack of future growth, undervalued stock and lack of management confidence. If the

company decides to spend its funds on its own shares instead of making re-investment through
acquisitions or capital expenses, then it signs to the investor that company is not more profitable,
and does not productive opportunities for business growth (Mehdi, Sahut, and Teulon, 2017).
From the perspective of shareholder, since each share becomes more valuable and each share
retains a higher percent of corporate ownership, plus the law of demand and supply come into
effect, there if higher demand for company share of stock and lower supply, thereby increase in
share prices (Booth, and Zhou, 2015). In addition, there is advantages for agency costs, it is
required that agency costs should be decreased; this takes place due of scarcity of resources.
When the cash flow gets integrated with the interest expenses, then ultimately there will be
reduction in financial flexibility. A repurchasing plan can create a negative impact upon the
financial flexibility of the company (Booth, and Zhou, 2017).
The repurchase of share would not solve the problem of financing and dividend of Eastboro.
Buying the shares back will further make reduction in the accessible resources for a dividend
payout. In addition, there might be inconsistency in the stock buyback with the signal that the
Eastboro is attempting to show, which is that it a growth company. It is to be noted that, tax on
dividends are levied as the ordinary income in the year, they are derived while the sale of stock is
taxed when it is sold. In addition, when the company holds stock for over 1 year then it can be
subjected to lower capital rates. Buyback of share gives a strong signal to shareholders that the
company is going through underpriced scenarios (Baker, and Weigand, 2015). Similarly, the
Eastboro could be adopting the repurchase of share from some shareholders as a means to
distribute cash.

QUESTION 5
The director of the investor relation of Eastboro, has review the position of the company in the
market. He contended that, growth of the company has not been properly perceived by the
investor and the existing name of the company is more resemble with the historical product mix
and market as compare with the expected market of the company in the future. Image advertising
campaign and corporate name plays a very important role for the promotion and marketing of the
company. It assists the company to establish brand image in the mind of investors (Assaf etal.
2017). The company can improve their creditability and increasetheir sales through the
advertising campaign. Along with this, acquiring new customers, retention of the consumers,
awareness of brand, changing brand perception, increasing engagement and others are some
benefit which can be avail by image advertising campaign and corporate name (McAlister et al.
2016). On the basis of the above benefits, it can be concluded that Campbell recommend the
corporate – image advertising campaign and corporate name change to the directors. However,
earning and the growth of the company cannot be changed by the advertisingcampaign alone. It
is important to communicate with investor or market analyst regarding their future plans. It leads
to rebuilding of the position of the company in the target market. Along with this, if all the plans
and procedures of the company produce the result, as per expectations then corporate –image
advertising campaign can be successful in assisting the company to obtain the desired position
(Sahni, 2016). Moreover, the dividend policy does not directly impacted by the advertising
campaign. On the other hand, this campaign can support the dividend policy. Successful
rebuilding of the position can help the investor or the market to recognize the reason that why
lower dividend is not awful indication towards the company, however in retaining with new

position of the company as high growth excellent technological and advanced company (Oh et
al. 2016).
CONCLUSION
By considering the relevant facts and figures, it can be concluded that Eastboro must pay the
promised dividends to shareholders, plus it must adopt the 40% dividend policy to increase its
market confidence and prices of share. However, the buyback of share is evidenced as bad option
for the growth strategy for company, as it will lower down future growth, confidence, share
prices and stock.

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