Final Case Study G M Machine Tools Corp

8/10/2019 Final Case Study G M Machine Tools Corp

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GAINESBORO MACHINE TOOLS CORPORATION

Submitted By:in tics

Rahul NarediMP13039Shadab Akhter - MP13050

Samadarshi SarkarMP13046

Nishant KumarMP13037

Chawar SinghMP13073

Gaurav GulatiMP13024

Amit ChakrabortyMP13006

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


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Dividend Payout Ratio :

Target dividend payout :

0% 20% 40% 50%

Net profit $537.8 $537.8 $537.8 $537.8

Less dividends - 107.6 215.1 268.9

Earnings retained 537.8 430.2 322.7 268.9

New debt (stock buyback) (119.3) (11.9) 95.5 149.2

Depreciation 252.0 252.0 252.0 252.0

Increase in assets 670.4 670.3 670.2 670.1

Initial debt (2004) 80.3 80.3 80.3 80.3

Change in debt - - 95.5 149.2

Ending debt (2011) 80.3 80.3 175.8 229.5

Initial equity (2004) 282.5 282.5 282.5 282.5

Earnings retained 537.8 430.2 322.7 268.9

Stock buyback (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 10.3% 10.3% 22.5% 29.4%

Debt / equity 11.5% 11.5% 29.0% 41.6%

Debt capacity 280.4 280.3 242.1 220.6

(@ 0.4 = max debt / equity)

Debt capacity used 80.3 80.3 175.8 229.5

Unused debt capacity 200.1 200.1 66.3 (8.9)

Ratio of debt capacity used for

incremental payments to

shareholders 1.40 1.40

Targeted Dividend Payout


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Debt/Equity Results Sensitivity to Variations in Payout Ratio

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 dividend-

payout 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 adversedeviations 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 research-

and-development (R&D) expenses and reduce net margin.

Dividend payout 2005 2006 2007 2008 2009 2010 2011

0% 34.6% 33.2% 27.6% 21.0% 12.2% 6.0% -5.2%

10% 35.5% 35.6% 31.7% 26.5% 18.7% 13.1% 2.2%

20% 36.4% 38.2% 36.1% 32.5% 26.0% 21.4% 10.9%

30% 37.2% 40.8% 40.8% 39.2% 34.2% 30.9% 21.2%

40% 38.1% 43.5% 45.8% 46.5% 43.6% 42.0% 33.7%

Max. D/E ratio 40.0% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0%


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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, new-

competitor 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 theresources 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.


5/5

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 impli ed 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 relationbetween 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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Documents

Final Case Study G M Machine Tools Corp