Eastboro Machine Tools

Corporation

PRAMITA SAHA, PRADEEP RAJORA , ZIXUN QIN

Executive Summary:

Eastboro Corporation was founded in 1923 as a manufacturing and designing company in New

Hampshire. It entered in the field of manufacturing CAD/CAM in the late 1970s.

Firm's corporate goals include strategy of three main key points: substantial shift of mix of

production, international expansion and expansion through joint venture and acquisition. Firm

was mostly debt averted and history for past 25 years shows highest debt capital ratio was 22%.

Jennifer Campbell needed to submit a recommendation regarding the dividend policy.

Aggressive competition was one of the main factors why Eastboro's performance started to fall.

Two main factors affected sales of Eastboro which are: Strong competitors and downturn of US

economy. Recently with the restructuring and a new system named as "Artificial workforce"

gave an optimized view to the investors. Some security analysts had started to believe it as a

growth stock. Eastboro needs to take decision on what policy to choose: stock repurchasing or

dividend payout policy, if dividend policy, then zero payout, 20%, 40% or residual dividend

payout policy?

Resuming dividend payments are important to avoid transaction cost, giving signal of

overcoming problems and being confident about potential future and taking advantage of

dividend clientele. Repurchasing stock is helpful when the value is underpriced in the market.

Institutional investors are also more satisfied with stock repurchase for having more favorable

tax consequences. In order to have a proper reflection of product and market mix, an image

advertising campaign is necessary for Eastboro.

In order to fund an increased dividend payout or stock buyback, firm can choose any of the three

factors: invest less, borrow more, or issue more stock. As firm had more debt aversion, firm is

more willing to vary investment and issuing more stock. In the current market situation it is not

optimal decision to issue more stock to raise capital. Also, investment is very necessary in order

to achieve growth rate 15%.

We have analyzed the four dividend policies to see which one fits best with the financial

strategies of Eastboro. We have applied zero dividend payout policy, 20%, 40% and residual

dividend payout policy. In order to find out the dividends in residual dividend policy, we have

used "Solver" function to let Microsoft Excel find out the feasible dividend payout ratio with the

maximum debt to equity ratio in the given situation and information from year 2001 to 2007.

Then we have discussed why 20% dividend payout policy is more feasible for Eastboro in

comparison to other policies.

In the next section, we have calculated with DCF (Discounted Cash Flow) analysis in order to

find out the intrinsic value of the firm. Due to the unavailability of information we had to make

some assumption according to the question and then we applied formulas to find out the free

cash flows, terminal values, firm value and equity value per share as well. Although, the result

showed the intrinsic value gives very good premium to repurchase share, we discussed why it

should not give the optimum result for Eastboro.

We have given recommendation supporting the image advertising campaign because we believe

it can help to influence growth through advertisement.

Finally, in recommendation we have summarized our suggestions step by step and explained the

reasons for supporting those suggestions.

Question Number 1:

Discuss the main issues Campbell is facing. That is, explain why she is considering each of the

following and why they are potentially important to Eastboro: a. resuming dividend payments b.

repurchasing stock c. embarking on a corporate-image advertising campaign and name change

You should shape your discussion in light of both your class notes and Eastboro’s recent

financial performance issues and the stock market downturn following September 11, 2001.

Why she is considering:

 Despite of having tradition of strong earnings and dividend growth, Eastboro had faced

unsteadiness in the recent years. After that, implementation of restructuring was followed

by net losses. In 1999, dividend decreased drastically.

 There is also a consideration of corporate image advertisement by the senior management

with the change of name to "Eastboro Advanced System International, Inc". The intention

was to develop the perception of the company especially in the investment community.
 Eastboro's new system "Artificial workforce" gives the optimistic view about potential

growth in future to the security analysts. Newly developed tools and machines showed

the possibility of rendering competitor's product obsolete. The new growth and

profitability potential demonstrates Eastboro as a resurgent company and some analysts

believe these possibilities will turn this company into a growth stock.
Why they are potentially important to Eastboro:

a. Resuming dividend payments

In the light of the case:

 East, one of the two basic founders of Eastboro, was interested to improve its domestic

market share. He wanted to leave a legacy of technological advancement and financial

strength before his retirement. With the beginning of bearing fruit of Artificial Workforce,

he wanted to ensure the ability of Eastboro to pay dividend.

 In order to give a signal of overcoming all the problems and confidence of future

earnings, a large dividend (for example, 40% payout) will work most. Some members of

management also gave opinion that if the predicted growth rate ranges from 10% to 20%,

there should be a payout from 30% to 50%.

In the light of the notes:

 Transaction cost and current income:

The direct cash expenses like brokerage fees and other transaction costs are higher

in case of low-dividend stocks and can be avoided in case of high dividend stocks. Desire

for current income of the investors lead them to pay premium to gain a higher dividend

yield. If Eastboro chooses to pay higher dividend payout, then they will be able to attract

more investors with the desire of current income.

 Dividend Clienteles:
On the basis of preference in different tax and current income situations, a set of

investors choose the stock of the firms that have their preferable dividend policy. This

"Dividend Clienteles" policy helps to increase the market value if management is able to
 appeal to investors whose preferences are not really very satisfied in the current situation.

Eastboro can also take the opportunity to increase their market value with this policy.
 Information asymmetry and signaling:
The conveyance of value related information to public reveals company's

information to the competitors too. There is also probability of imitating signals by the

weaker firms. Dividend can give a signal that will be highly expensive to mimic for lower

value firms and also, information remains confidential with this type of signal.

b. Repurchasing stock

 Under pricing:
If the management find out that the current market price is underpriced, it would

be more effective to take the advantage of the situation by repurchasing the shares from

the market. Eastboro DCF calculation shows that their stocks are highly underpriced in

the market. So, it is the best opportunity to take the advantage of this.
 Institutional ownership:
Institutional investors (taxable investors) have more favorable tax consequences

in the case of selling shares than the tax consequences in the case of having dividends.

So, the institutional owners prefer repurchasing shares. Almost 20% shareholders are

institutional investors for Eastboro. This 20% of shareholders might be more satisfied

with the exercise of repurchasing shares.

c. Embarking on a corporate-image advertising campaign and name change

The perception of the company in the investment community needs to be improved. According to

Cathy Williams, director of Investor Relations, the name is more consistent with the historical

market and product mix. Misconception about the prospects of Eastboro, such as, low outlook on

shareholder returns and growth prospects by the stockbrokers, low awareness about the business

of Eastboro among magazine readers etc. can be eliminated or reduced to a great extent by a

campaign of corporate image advertising.

Question Number 2:

As a follow on to question 1, discuss whether (and how) any of the previous actions (1a-c)

potentially conflict with Eastboro’s ambitious growth goals.

Conflict with Eastboro’s ambitious growth goals:

a. Resuming dividend payments

Technologies advancement will need huge cash requirements. For a high growth and high

technology firm, market normally has expectation for capital appreciation. Recent performance

problems also help to think twice about the "wisdom of ignoring the financial statements in favor

of acting like a blue chip". In this situation, it would be wiser to use Zero dividend payout

because firm needs more money to make investment and prove itself as a "Technologically

advanced CAD/CAM company", rather than "a traditional electrical-equipment manufacturer".

b. Repurchasing stock
The following calculation of DCF (Discounted Cash Flow) will show that Eastboro has higher

intrinsic value than the current price indicating the stock price is underpriced. Although, it seems

to be the higher time to take the advantage of this value difference by repurchasing shares, the

real situation is different. Eastboro wants to convey the signal of being a growth company and

overcoming of all the past problems to the investors. Repurchasing share will be very

inconsistent with the signal of being a growth company.

c. Embarking on a corporate-image advertising campaign and name change

Cathy Williams, director of Investor Relations in Eastboro, gave an estimation of $10 million as

cost of image advertising and name change campaign. There was no empirical evidence of stock

price response to image advertising and name change. So, if the image advertising and name

change campaign does not influence the stock price responses, then this decision will be a waste

of money when the firm is facing poor performance.

Question Number 3:

What risks does the firm face? The case details the nature of the industry, the strategy of the firm

and the firm’s performance, among other things. Highlight these points in your discussion.

(Please do not recite large sections of the case—summaries are sufficient.)

The Eastboro Corporation was established in 1923 and manufactured machinery parts, metal

press, dies and molds, however the firm grew around the period of war in 1975 where firm

manufactured tanks, armed vehicle parts and miscellaneous equipment’s for the war including

riveters and welders, after war it produced press and molds for plastic and metals. Advancing its
manufacturing unit with CAD/CAM and entering into rim with large software firms including

GE, HP and DE, being an leader among many domestic firms where it holds 85% of total

revenue from manufacturing form regional based plants, level of risk increases rises due to

growth bounded by geographical factors like the rise of the U.S dollar in economy don’t have

positive attitude to encouraging the industry which dampened the sale of exported goods which

almost contributes to 45% and aggressive entry of large foreign firms in field of CAD/CAM

which takes the 45% of the total sales.

Revenue and Profit advocates for the firm performance lieu of the competition competitors could

develop the similar system as the Artificial Workforce in the future time and reduce the Eastboro

company revenue or attack like September 11,2001 which triggered the market to see low

figures, but if the firm has to fight to sustain profitable or improve net losses repetitively the firm

like Eastwood had to undergo through major reconstruction of the firm in order to eliminate

losses; where Eastboro had weakened in the past five years in the mid 90’s and extraordinary

losses in 2000 although providing dividend. Eastboro had to take the risk of $202 million in

reconstruction of the firm giving new direction to firm to increase sales and profit in market

field, eliminating unprofitable assets and lease facilities also laying off unnecessary employees.

One of the most important risk the firm face is to maintain its reputation in favor of stockholders,

creditors and analysts that tend to predict the firm’s growth & future performance on the basis of

dividend or payout policy, however the figures states that Eastwood have a habit of high paying

dividend and tend not to break it, even being in constant losses.

All in all, regardless of the macroeconomic environment, the management keeps the positive

attitude about the company’s prospects where even the management looks for firm growth with

best interest of maximizing the public shareholders wealth first.

Question Number 4:

One of the issues that may not be clear until you do numerical analysis is that this case deals

with setting policy within a financing constraint. In theory, to fund an increased dividend payout

or stock buyback, a firm might invest less, borrow more, or issue more stock. Which of those

three elements is Eastboro’s management willing to vary and which elements remain fixed as a

matter of its policy? For those elements that management is willing to vary, discuss whether

management should vary them given the current situation.

Which of those three elements is Eastboro’s management willing to vary and which

elements remain fixed as a matter of its policy:

Eastboro's management keeps borrowing as a fixed matter of policy. They had an aversion to

debt. They had debt to capital ratio 22% as highest in the past 25 years. They are considering

varying- investing less and issue more stock.

Whether management should vary them given the current situation:

 If management wants to go for dividend policy with stock dividend, then they have to

issue new stock. In this case, Eastboro has underpriced value in the market. They have

the scope for repurchase too. After more analysis, they can go for either dividend policy

or stock repurchase. According to the case, the economy is facing downturn after the
 terrorist attacks. During this downturn, it will be very difficult to raise capital with the

issue of new stocks and it will come with extra transaction costs.
 "Investing less" should be given more consideration. This factor should not be a matter of

"willing to vary" because investment is very necessary to achieve the growth rate of 15%.

In order to achieve the goal, they have three key plans:

1. Shifting mix of production substantially

2. International expansion
3. Joint ventures and acquisitions of small software companies

In additional, internal research would provide one half of the new products.

Overall, investment is very necessary to materialize this entire plan in order to achieve the

growth rate eventually.

Question Number 5:

5. As a follow-on to question 4, what happens to Eastboro’s financing need, unused debt capacity

and debt/equity ratio 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 Exhibit 8 in the case presents an estimate of the amount of borrowing needed,

assuming a 40% payout. Assume that maximum debt capacity is, as a matter of policy, 40% of

book value of equity.)

Based on your calculations, what is the maximum payout ratio that is consistent with Eastboro’s

financial policy?

a. No Dividends are paid:

Given the assumption:

All the information was given in exhibit 8, except the assumption of dividend payout ratio. For

no dividend paid policy, we have assumed 0% dividend payout ratio. Here, we get the sources by

adding net income and depreciation. Then uses are the summation of capital expenditure and

change in working capital. Excess cash / borrowing needs = Sources - Uses. Net = Excess cash -

dividend. Cumulative source = Net + previous cumulative source need. Interest cost on new debt

after tax = Cumulative source * (1-tax) * Borrowing rate. Net source = Cumulative source-

Interest cost on new debt after tax. Debt (excess) = Previous year debt - Net source. Equity =
Beginning equity - Dividend + net income - Interest cost on new debt after tax. We are taking

equity cell as the same amount of beginning equity in the next year. Here, Debt - Equity ratio =

Debt / Equity. Unused debt capacity says about the dollar amount for the difference of the

maximum debt capacity and what we have.

b. 20% payout ratio:

The only difference with the previous one is we applied 20% dividend payout ratio.
c. 40% payout ratio:

Then we applied 40% dividend payout ratio to see what happens:

Firm has less unused debt capacity here, but it violates the financial strategy of maintaining 40%

debt to equity ratio.

d. Residual payout policy:

In order to get the dividend payout ratio we applied the "Solver" function to let Microsoft Excel

work on finding the dividend payout ratio percentage. We used "Debt Equity ratio" as our target

cell and changing the cell "dividend payout ratio" with subject to "unused debt capacity" = 0.

Here is an example for year 2007, where H42 shows Debt Equity ratio, H9 shows dividend

payout ratio and H44 shows unused debt capacity. Here, we did not get any values for year 2002

and 2003 because in those cases, the debt equity ratio is already higher than 40% and unused

amount is negative.
The residual payout policy is good for using optimal amount of debt capacity, but it does not

show any trend of dividend. Sometimes it is extremely higher, sometimes it is 0%.

Scenario analysis of these policies:

It is a scenario given the situation where it shows what happens to debt equity ratio and unused

debt capacity in each case.

60.0%

50.0%

40.0%

No Dividend =
30.0%
20% Payout raio =
40% payout ratio =
20.0%
Residual Pauout =

10.0%

0.0%
2001 2002 2003 2004 2005 2006 2007
-10.0%
 400.00
350.00
300.00
250.00
No Dividend =
200.00 20% Payout raio =
150.00 40% payout ratio =
Residual Pauout =
100.00
50.00
0.00
2001 2002 2003 2004 2005 2006 2007
-50.00

For zero dividend payout firm gets the chance to invest money in other valuable projects to make

more growth and expansion as well, but it prohibits giving signal to investors. The 20% payout

policy keeps more unused debt capacity than the rest of two choices. As the case says that

Eastboro has an aversion to debt, the unused capacity of debt is not a problem for them. 40%

payout is higher for Eastboro now because it is now difficult to say whether it will be able to

maintain the dividend for future or not. On the other hand, residual policy provides the dividend

policies which are very different each year. So, in order to give investors signal, maintain a

decent trend of dividend and also to ensure enough money for further investment in business

expansion, among the policies 20% payout ratio is most consistent with Eastboro's policy.

Question Number 6:

How might Eastboro’s various providers of capital, such as stockholders and creditors, react if

Eastboro declares no dividend in 2001?

Despite of making trivial earnings in past five years, firm has even rewarded dividends

regardless having largest share earning loss in 2000, nourishing the faith of investors in the firm,

however after the two major reconstructions, the firm is quenching for capital to grow,

meanwhile the obligation to provide dividend just to please stakeholders and creditors isn’t worth

to break 40% debt-to-equity ratio.

We believe Eastboro’s stockholder and creditors will respect the decision as announcing no

dividend just in 2011 rather financing its (internal developing projects). Even though

reconstruction seems to be a necessity as the ability to reconstruct profit depends on management

ability which in turn will benefit the investor's interest for future.

The arguments for and against the (a) zero payout:

FOR: theoretically speaking Eastboro’s hope to nurture its expansion is likely to be impossible if

they are plan on paying dividend to their investors, as they are already making loss and

increasing debt to pay dividend won’t help the firm as well as investors, however if the decide to

fully retain and invest in its developing project or fund international growth, firm will sooner

make profit as well as attract new international investors.

Zero payout with a plan of offset some shareholders for a short time with small expected loss or

even no profit scenario, however for a long term as firm management wants to grow and change

the image for future being directed to be a “mature growing company or developed firm” rather

than “dividend paying company”.

AGAINST:
Many view this policy as dawn of the era of Eastboro Machine Tools Corporations as the firm is

making loss in the recent years and maybe announcing Zero dividend will discourage potential

future investors as misapprehending firm's future plan and strategies.

Many institutions, analyst and individual investors predict firm future growth by its future

dividend position, and obviously zero payout policy may sign them as non-growing firm, again

accidently disappointing market.

(b) 40% payout:

FOR: Following this policy it would definitely restore the Stockholder and creditors faith with an

annual dividend payment of $0.80 per share making highest since 1997. It advocates its own

growth with an increase in sale and order of current share price to $32 a share.

After the reconstruction of the firm Investors and beneficiaries believe that a strong signal with a

large dividend of 40% payout to its shareholders will sight that firm has overcome its problem

and management is confident in ensuring its future growth.

AGAINST:

With 40% payout policy, the firm will linger to borrow money even in future until 2007 given

estimates ,which in turn will deter the firm growth in domestic as well as international market

and restrain expansion even in on-going development project leading to huge debt with less

probability to overcome in near future.

One of many firms policy was to maintain its debt only to finance its working capital of the firm,

however financing dividend will not only break policy also firms capital backbone just to please

stockholders and letting the whole firm risking the future course.

We disagree with this policy as its hinders the firm growth as of now, also safeguarding its future

with anticipating short term loss is in the best interest of the Eastboro as well as long term

investors.
(c) The residual payout policies:

FOR:

Even though few members of the firm agreed and argued in favor of this policy as dividends

should only be paid out after funding all projects offering positive net present value. This policy

states that investors funds should be deployed at returns into projects or else payback them in the

form of dividends, funds deployed in project with higher return than dividends will restore trust

and confident.

Obviously, in this scenario there are many possibilities for the firm to direct its growth,

compromising its future with increased debt and low performance, however if lower dividends

with stock repurchase at current price will help the firm in increasing value.

Firms dependence will be lessen burden of increasing debt or borrowing capital and predictable

loss.

AGAINST:

In this scenario the Eastboro’s dividends can be unpredictable, may be even zero, striking market

may act harsh on firm share price.

What should Campbell recommend to the board of directors with regard to a long-run

dividend payout policy for Eastboro?

As the CFO of the company Campbell is aware of the firm situation and quoting his recent

studies and putting recommendation based on the trend and the facts that benefits the such as ; a

recent published study stating that firms displayed lower inclination for the firms paying
dividend, as firms paying cash dividends has dropped from 65% to 20% from 1978 to 1999,

stating that trend is shifting as potential investors do see benefit in long term investment, not just

pleasing with dividends, however the firm has undergone a major reconstruction as devoting a

major financing its R&D budget in field of CAD/CAM and selling unprofitable business,

refocusing its sales and marketing approach reflecting a strong possibility of future growth and

should opt for 20% payout policy as with lowering the payout ratio and with a new strong image

of Eastboro Advance Systems will be seen as blue-chip investment.

How her recommendation might be influenced by who owns the shares:

Campbell is one the senior most management employee and holds a part of 20% in “Employees

and families” shares, she might have a big responsibility being CFO but as an individual having

securing their part of shares does matters to her, we believe there are following reasons where

here recommendations might be influenced by having shares in firm:

a) There may be chances where she indeed doing her job to make the finest decision based on

analyses and assumptions with a double motive to help the firm as well as herself, motivating her

to diligently working on her assignment to make the judgment in the best interest of the firm to

be profitable which in-turn will yield her motive too.

b) She might want to hold the firm shares for a long time and being an insider wants to cash out

the most from given opportunity by having responsibility in making judgment for long term

future curse of financial actions, which may drive her to only think for long term plans rather

than making best choices to foresee shot term plans.

c) Campbell may not want to risk her investment or may not be a risk taker at all, this can or

might too be a reason where she deters to take short bold steps in firm's decisions as fear she

might lose her part of investment too.

Question Number 7:

Similar to question 6, how might various providers of capital, such as stockholders and

creditors, react if Eastboro repurchased shares? How would this affect the dividend decision?

Should Campbell recommend repurchasing shares?

(Hint: Determining the intrinsic value of Eastboro’s shares and comparing that value to the

market price would be prudent in making this recommendation. While there is not enough data

in the case to accurately project free cash flows, make the following assumptions to estimate

FCFs and value them with a DCF model: use net income as a proxy for operating income,

assume a WACC of 10% and a terminal growth factor of 3.5% after 2007. Exhibit 8 has

projections through 2007 to aid you in this.)

DCF calculation:

The given information is used as assumptions. The number of shares outstanding is given in the

case (Exhibit 5):

As per the question instructions, we have taken the net income as the operating income, long

term growth rate as 3.5% and WACC =10%. We have calculated free cash flows with the

formula:

Source: Google.com

Terminal value is calculated with the formula:

Source: Google.com.
Then we took the present values of discounted factors and calculated the present values of Free

Cash Flows.

Then we added all the values to get total value and then divided with the number of shares

outstanding to get the price per share. The current price is given in the 1st paragraph of the case

which is $22.15. So, the premium for being underpriced in the market we get here is 66.67%.
Reaction from provider of capital:

On the basis of the calculations, Eastboro should probably go for share repurchase. As previously

said in the question number 2, stock repurchasing is inconsistent with giving signal about being

growth stock. So, people will react by not considering it as a growth stock, rather it will be

considered more as a traditional equipment manufacturing company.

How would affect dividend decision:

Stock repurchase will reduce the resources for dividend payout. People will sell the shares on

which they would get dividends in case of dividend payout.

Campbell's recommendation:

If we take decision on the basis of calculations only, then yes, Campbell should recommend

repurchasing shares. Basically, management goes for repurchasing shares when they are not sure

enough to be capable to maintain a stable dividend payout ratio. If management is confident

enough to maintain the dividend payment in the future years, they prefer to go for dividend. FCF

is positive and going up from year 2003. So, Campbell can do further analysis about projections

and then she can take decision on the basis of growth rate, debt target and other factors.

Question Number 8:

Should Campbell recommend the corporate-image advertising campaign and corporate name

change to the directors? Why or why not? (Consider and discuss whether this campaign will

attract a particular type of clientele to the firm’s shares and/or convey any sort of credible signal
regarding the firm’s goals for the future.) Do the advertising and name change have any bearing

on the dividend policy or stock repurchase policy you propose? If so, how?

Yes, indeed Campbell should recommend the corporate-image advertising campaign and

corporate name change to directors because it was believed that’s its future growth might also

come from advertising and a name which is likely to be more suitable with the products of the

company so they came up with “Eastboro Advanced System International, Inc” the objective of

this campaign was to enhance the awareness and image of Eastboro. Moreover a survey of

financial magazine stated a low awareness Eastboro and its business.

For some reason Eastboro image was dampened due to relatively low earnings in the past 5 years

as well as in a major reconstruction where firm had to sell off its unprofitable lines of business,

two plants, and eliminate five lease facilities and personal, it’s obvious that after this major

reconstruction where the firm had to reduce its assets because of incompetent to make profit,

market doubts the credibility of the firm to make future profits associated with its name.

This campaign of making new image with changing the name towards the market is to suit the

product they make and strategy they opt, previously the firm was known for high dividend

payout however the environment and investors segment has transformed, now the firm is willing

to hold on long term investors and prove its credibility making itself more of a growth firm.

Though this campaign will cost them about 10 million dollars.

The new awareness plus advertising approach will benefit to improve the exposure about the

firm within the industry market as well as creating potential customers, and research shows that

firm still hasn’t explored many charted territories and international market; hence that’s where

advertisement plays its role.

We do believe that, change of name and advertisement will indirectly have valuable effect on

dividend policy as they are indicating to the market that they will be devoted towards future

growth and will be no longer depended on retaining shareholders just on dividend payout policy.

Moreover the firm is currently undervalued where it has the opportunity grow with a stronger

future.

Question Number 9:

Finally, summarize your overall recommendations regarding the dividend payout policy,

repurchasing shares and the corporate-image advertising campaign. Make sure that your

recommendations as a whole are consistent and feasible given the firm’s financial constraints

and policies.

Stock repurchasing or dividend policy:

Eastboro has to choose between stock repurchase and dividend policies. Although the DCF

calculation shows the stock are underpriced and can provide premium more than 65%, stock

repurchasing is inconsistent with the signaling method. Eastboro has a potential for growth stock

and the expected growth rate is 15%. As a high growth and high technology firm, stock

repurchasing will be contradictory to signal that Eastboro's management wants to send to the

investment community.
No dividend, 20% payout, 40% payout and residual payout policy:

Zero dividend payout policy has excess amount of unused debt capacity. Secondly, security

analysts, who view Eastboro more as a technologically advanced company rather than a typical

traditional equipment manufacturer, expect capital appreciation in the way of dividends.

A Wall Street Journal article indicated that after the collapse in technology and growth stocks,

has indicated that people will pay more attention to dividend and current earnings rather than

growth. A 40% dividend payment policy will be more useful to provide signal to investors that

Eastboro has overcome all the past problems and management has more confidence about the

earnings in future. In order to implement this policy, Eastboro will have to borrow a huge amount

of money to pay for dividends and investment as well. In most of the years from 2001 to 2007,

40% dividend policy requires to borrow more than 40% of debt to equity ratio. So, it is

inconsistent with the financial strategy of Eastboro.

20% dividend payout policy is pretty consistent with the financial strategy of Eastboro. It shows

the dividends are consistent in those years. Eastboro can support investment and dividends by

borrowing money without violating their financial strategy. It will help Eastboro to take

advantage of signaling and dividend clienteles. Eastboro can attract investors by adopting

particular dividend policy for them whose priorities are not satisfied by the market.

Residual payout policy requires paying dividend after all NPV projects are funded. This policy

would help Eastboro to grow and expand very well, but the dividend payouts do not follow any

trend and are very unpredictable.

Corporate-image advertising campaign:

The corporate image campaign is necessary for two reasons:

Misperception about firm's prospects: Survey revealed magazine readers have very low

awareness about its business and stockbrokers have low outlook on growth prospects and

expected returns of Eastboro.

Consistency with historical product and market mix: Current name was more consistent with the

historical product and market mix. Eastboro is more than a traditional equipment manufacturing

firm now. Its new growth as technologically advanced company should have a suitable name that

reflects the image.

Advertising also can influence growth rate. In order to prove credibility as a growth firm, this

campaign is necessary to reflect their proper image with their strategy, product and market mix.

Finally, we recommend dividend policy over the stock repurchase, because the strategies and

goal of the growth become contradictory with stock repurchase due to signaling issue and also

specifically 20% dividend payout among the policies as other policies are not consistent with the

financial strategies of Eastboro.

Reference:

1. MSF Advanced Corporate Finance (Custom Case Book for FIN 6750) by McGraw Hill Create.
2. Advanced Corporate Finance: Policies and Strategies by Joseph Ogden, Frank Jen and Philip O’Connor, 1st
Edition (2002), Prentice Hall
3. Principals of Corporate Finance by Richard A. Brealey, Stewart C. Myers and Franklin Allen, 11th Edition,
McGraw-Hill, 2015