Case Study On Electronic Timing Ltd Essay

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?€ђvarying 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.

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