Sara Larson is the chief financial officer of Rockboro Machine Tools Corporation, a large CAD/CAM (computer-aided design and manufacturing) equipment manufacturer. Sometime in 2015, she was faced with the challenge of deciding whether to pay out dividends to the firm's shareholders, or repurchase stock. If she chooses the first option, she must also come up with the amount of the payout. Another issue, in this case, is whether the company should go into corporate-image advertising and change its corporate name to reflect its new outlook.
Kenneth Eades
Harvard Business Review (UV7227-PDF-ENG)
December 14, 2016
Case questions answered:
Case study questions answered in the first solution:
- What are the problems here, and what do you recommend? What should Larson recommend?
- What is the nature of the dividend decision that Larson must make? What are the pros and cons of the alternative positions? (Or alternatively, why pay any dividends?) How will Rockboro’s various providers of capital, such as its stockholders and bankers, react to a declaration of no dividend? What about the announcement of a 40% payout? How would they react to a residual payout?
Case study questions answered in the second solution:
- 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 Rockboro Machine Tools Corporation’s management willing to vary, and which elements remain fixed as a matter of company policy?
- What happens to Rockboro’s financing needs and unused debt capacity if:
a) no dividends are paid?
b) a 20% payout is pursued?
c) a 40% payout is pursued?
d) a residual payout policy is pursued? Note that case Exhibit 8 presents an estimate of the amount of borrowing needed and assumes that the maximum debt capacity is, as a matter of policy, 40% of the book value of equity. For purposes of this limitation, bank loans and long-term debt are the only liabilities considered. - How might Rockboro’s various providers of funds, such as its stockholders and creditors, react if Rockboro declared a dividend in 2015? What are the arguments for and against the zero payout, 40% payout, and residual payout policies? What should Sara Larson recommend to the board of directors with regard to a long-term dividend payout policy for Rockboro Machine Tools Corporation? Why?
- How might Rockboro’s various providers of funds, such as its stockholders and creditors, react if Rockboro repurchased its shares? Should Rockboro institute a share-buyback plan? Why?
- Should Larson recommend the corporate image advertising campaign and corporate name change to Rockboro’s directors? Why? Do the advertising and name changes have any bearing on the dividend policy or the stock-repurchase policy that you propose? Why?
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Rockboro Machine Tools Corporation Case Answers
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1.) What are the problems here, and what do you recommend? What should Larson, as the chief financial officer of Rockboro Machine Tools Corporation, recommend?
There are various problems mentioned in the case of Rockboro Machine Tools Corporation, which mainly started after 2008-2009. The following are some of the problems faced by the Rockboro Machine Tools Corporation.
- The company was not able to recover its profit margin after the financial crisis of 2008.
- Also, it faces much competition from its most promising segment of the business (CAD/CAM equipment) and has an uncompetitive cost structure.
- Also, the management of Rockboro Machine Tools Corporation has contradicting views regarding the future of the company and the payout of dividends to shareholders.
- Also, they are now becoming technologically advanced, but the name of the company is more connected with its historic product mix.
- Due to these problems, there are various dilemmas faced by management and Larson.
- They face whether to declare the dividend or not, give a 40% dividend, or have a residual dividend payout. The problem with dividend payout is low earnings, even if the company has various growth opportunities. However, in the past, the company has followed a steady dividend payout ratio. After two months in 2015, in a special letter to shareholders, directors declared an intention to continue the dividend payout later in 2015.
- Whether to buy back the share or not was also a challenge for the company. Also, the buyback of shares was last done in 2009. Most of these were done to increase the price of their share. Still, it was not seen in the case of Rockboro Machine Tools Corporation, and also, due to buyback, it would hinder the Debt-Equity ratio, which is against the company’s philosophy.
- To change the company’s name to Rockboro Machine Tools Corporation Advanced Systems International, Inc. and indulge in its image advertising. From the survey done by the Rockboro Machine Tools Corporation’s director of investor relations, Maureen Williams, it was concluded that the investor misperceived the firm’s prospects. The firm’s current name was more consistent with the historic product mix of Rockboro Machine Tools Corporation. As per the consulting firm’s advice, Rockboro Machine Tools Corporation should change its name to Rockboro Machine Tools Corporation Advanced Systems International, Inc. Still. The consultants have no proof that stock price would respond positively to corporate image campaigns or name changes.
If the Rockboro Machine Tools Corporation follows the policy of no dividend, it will save funds for its various projects for which the future is bright. Hence, the company would not require borrowing the funds or further issuing the shares.
I would not suggest a no-dividend policy as the company has followed a steady dividend policy for the last various years. The dividend policy is relevant to share prices in most instances. If Rockboro Machine Tools Corporation declares no dividend, this will…
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