Rockboro Machine Tools Corporation

Case Questions

1. What happens to Rockboro’s excess cash (or borrowing need), debt/equity ratio, 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 dividend payout policy is pursued?
Note: I have posted the exhibits in the case as a spreadsheet on Blackboard. The last
exhibit (Exhibit 8) is actually an excel model. You can change the assumptions in the
model to answer the questions above. Please prepare a summary table of your findings.
2. What risks does the firm face? Comment on the nature of the industry, strategy of the
firm, and firm’s performance. Also consider the impact of a decline in sales growth and
net income as percentage of sales on excess cash (or borrowing need) and unused debt
capacity (Here, you can again use Exhibit 8. You can consider 12% as sales growth and
net income as percentage of sales one percent less than the original model. Also try
different assumptions of sales growth and profit margin and evaluate the impact on
excess cash (or borrowing need) and unused debt capacity. Please summarize your
findings in a table).

3. What are the arguments for and against 0% payout, 20% payout, 40% payout, and
residual dividend payout policies?

4. How might Rockboro’s various providers of capital react to a change in payout policy?
(Here carefully look at Exhibit 4 and try to predict how different shareholders might react
to changes in payout policy (i.e., clientele effect). Also discuss how creditors might react)

5. What should Sara Larson recommend to the board of directors with regard to a long-term
dividend payout policy for Rockboro? Explain.

6. Should Rockboro institute a stock repurchase plan? How might shareholders and
creditors react to such a plan? Explain.

7. Should Larson recommend the corporate image advertising campaign and corporate name
change to the board of directors? Would the image campaign significantly affect the
implementation of the payout policy?