GAINESBORO MACHINE TOOLS CORPORATION

SubmittedBy:Finatics
Rahul Naredi MP13039
Shadab Akhter - MP13050
Samadarshi Sarkar MP13046
Nishant Kumar MP13037
Chawar Singh MP13073
Gaurav Gulati MP13024
Amit Chakraborty MP13006

Case Summary
Gainesboro Corporation is a company that began in 1923 as a manufacturer of metal machinery
parts which was in high demand during the Second World War. Since then, Gainesboro has
changed with the times, entering into the machine tool industry in 1975 and most recently has
transitioned into computer-aided design and computer-aided manufacturing (CAD/CAM)
equipment manufacturer. Recently, two events have events have taken place which have
further stressed the financial stability of the company; one being the Hurricane Katrina, which
caused an 18% drop in Gainesboros stock, the other being two company-wide restructuring
initiatives, which cost a total of $154 million. However, the latter comes with an upside: the
development of a new and innovative product which the company believes will give them an
advantage over their immediate competition. With Gainesboros financial strength in turmoil,
CFO Ashley Swenson must submit a new dividend policy to the Board of Directors. She must
decide whether more value will be added by paying shareholder dividends or to buy back
company stock, the objective being to achieve a 15% compounded annual growth rate.
By the end of 2004 the total sales were contributed as follows 45% of sales from CAD/CAM,
40% of sales from press dies and molds and remaining 15% was from miscellaneous parts.The
companys investment spending and financing requirements are driven by ambitious growth
goals (a 15% annual target is discussed in the case), which are to be achieved by a repositioning
of the firmaway from its traditional tools-and-molds business and beyond its CAD/CAM
business into a new line of products integrating hardware and softwareto provide complete
manufacturing systems. CAD/CAM commanded 45% of total sales ($340.5 million) in 2004 and
is expected to grow to three-quarters of sales ($1,509.5 million) by 2011, which implies a 24%
annual rate of growth in this business segment over the subsequent seven years. In addition,
international sales are expected to grow by 37% compounded over the subsequent seven years.
By contrast, the presses-and-molds segment will grow at about 2.7% annually in nominal terms,
which implies a negative real rate of growth in what constitutes the bulk of Gainesboros
current business. In short, the companys asset needs are driven primarily by a shift in the
companys strategic focus.
Following questions arises here:

Dividend payout ratio

How will creditors react to the dividends/Risk
Share Re purchase
Image advertising and name change campaign

Dividend Payout Ratio :

Target dividend payout :

Net profit
Less dividends
Earnings retained
New debt (stock buyback)
Depreciation
Increase in assets
Initial debt (2004)

Change in debt

Ending debt (2011)

Initial equity (2004)
Earnings retained

Stock buyback

Targeted Dividend Payout

0%
20%
40%
$537.8
$537.8
$537.8
107.6
215.1
537.8
430.2
322.7
(119.3)
(11.9)
95.5
252.0
252.0
252.0
670.4
670.3
670.2
80.3

80.3

50%
$537.8
268.9
268.9
149.2
252.0
670.1

80.3

80.3

95.5

149.2

80.3

80.3

175.8

229.5

282.5
537.8

282.5
430.2

282.5
322.7

282.5
268.9

(119.3)

(11.9)

Ending equity (2007)

701.0

700.8

605.2

551.4

Total capital

781.3

781.1

781.0

780.9

Debt / total capital

Debt / equity

10.3%
11.5%

10.3%
11.5%

22.5%
29.0%

29.4%
41.6%

Debt capacity
(@ 0.4 = max debt / equity)
Debt capacity used
Unused debt capacity
Ratio of debt capacity used for
incremental payments to
shareholders

280.4

280.3

242.1

220.6

80.3
200.1

80.3
200.1

175.8
66.3

229.5
(8.9)

1.40

1.40

Debt/Equity Results Sensitivity to Variations in Payout Ratio

Dividend payout
0%
10%
20%
30%
40%
Max. D/E ratio

2005
34.6%
35.5%
36.4%
37.2%
38.1%
40.0%

2006
33.2%
35.6%
38.2%
40.8%
43.5%
40.0%

2007
27.6%
31.7%
36.1%
40.8%
45.8%
40.0%

2008
21.0%
26.5%
32.5%
39.2%
46.5%
40.0%

2009
12.2%
18.7%
26.0%
34.2%
43.6%
40.0%

2010
6.0%
13.1%
21.4%
30.9%
42.0%
40.0%

2011
-5.2%
2.2%
10.9%
21.2%
33.7%
40.0%

Analysis above shows the effect of payout on unused debt capacity based on the
projection in case Exhibit 8. The top panel summarizes the firms investment program over the
forecast period, as well as the financing provided by internal sources. The bottom panel
summarizes the effect of higher payouts on the firms financing and unused debt capacity. The
principal insight this analysis yields is that the firms unused debt capacity disappears rapidly,
and maximum leverage is achieved as the payout increases. Going from a 20% to a 40% dividend
payout (an increase in cash flow to shareholders of $95.6 million),1 the company consumes
$134 million in unused debt capacity. Evidently, a multiplier relationship exists between payout
and unused debt capacityevery dollar of dividends paid consumes about $1.402 of debt
capacity. The multiplier exists because a dollar must be borrowed to replace each dollar of
equity paid out in dividends, and each dollar of equity lost sacrifices $0.40 of debt capacity that
it would have otherwise carried.
Whereas the abbreviated approach to analyzing the implications of various dividendpayout levels considers total 2005 to 2011 cash flows, the detailed approach considers the
pattern of the individual annual cash flows. Second data reveals that, although the debt/equity
ratio associated with the 40% payout policy is well under the maximum of 40 in 2011, the
maximum is breached in the preceding years. The graph suggests that a payout policy of 30% is
about the maximum that does not breach the debt/equity maximum.

Risk: Risk involved is neither the abbreviated nor detailed forecasts consider adverse
deviations from the plan. Case Exhibit 8 assumes no cyclical downturn over the seven-year
forecast period. Moreover, the model assumes that net margin doubles to 5% and then
increases to 8%. The company may be able to rationalize those optimistic assumptions on the
basis of its restructuring and the growth of the Artificial Workforce, but such a material
discontinuity in the firms performance will warrant careful scrutiny. Moreover, continued
growth may require new product development after 2006, which may incur significant researchand-development (R&D) expenses and reduce net margin.

Although restructuring appears to have been necessary, the credibility of the forecasts depends
on the assessment of managements ability to begin harvesting potential profits. Plainly, the
Artificial Workforce has the competitive advantage at the moment, but the volatility of the
firms performance in the current period is significant: The ratio of the cost of goods sold to
sales rose from 61.5% in 2003 to 65.9% in 2004. Meanwhile, the ratio of selling, general, and
administrative expenses to sales is projected to fall from 30.5% in 2004 to 24.3% in 2005.
Admittedly, the restructuring accounts for some of this volatility, but the case suggests several
sources of volatility that are external to the company: economic recession, currency, newcompetitor market entry, new product mishaps, cost overruns, and unexpected acquisition
opportunities

Share Re-purchase:
The decision on whether to buy back stock should be that, if the intrinsic value of Gainesboro is
greater than its current share price, the shares should be repurchased. The case does not
provide the information needed to make free cash flow projections, but one can work around
the problem by making some assumptions. Buying back shares would further reduce the
resources available for a dividend payout. Also, a stock buyback may be inconsistent with the
message that Gainesboro is trying to convey, which is that it is a growth company. In a perfectly
efficient market, it should not matter how investors got their money back (for example, through
dividends or share repurchases), but in inefficient markets, the role of dividends and buybacks
as signaling mechanisms cannot be disregarded. In Gainesboros case, we seem to have the
case of an inefficient market; the case suggests that information asymmetries exist between
company insiders and the stock market.

Image and Name change Campaign

The advice of name to be changed from Gainesbro Machine Tools Corporation to Gainsbro
Advanced system international Inc, this defiantly gives signals to shareholders that company
commits to future growth and international expanding strategy. Also it implied that companys
business will change from traditional machine tools to CAD/CAM.
Along with these came some disadvantages as well which is that, the campaign is costly nearly
costing to $10 Million, and neither is there any empirical evidence that shows the co relation
between the name change and stock prices.

Conclusion:
Share Repurchase: There should not be share repurchasing because it will lead to break dividend
commitments, no Major Benefit for the firm as performance is not too good also it will lead to
loss in Debt capacity flexibility
Dividend Payout ratio :
Yes there should be disbursement of dividends and this should happen at 20% rational already
shown above. This will help in to maintain board commitment to pay dividends. This can also be
seen as comparison strategy for investors who wants to receive dividends and those who wants
to see growth. This will also balance the financial needs and disbursement of free cash flow.
Image and Name change Campaign
The new name will better reflect companys new image also the new name Gainsbro Advanced
system international Inc. provides two main strategies to the investors which are High
technology and International Expanding. Further the 20% dividend payout supports the new
image of CAD/CAM focus.

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