Case 26 Rockboro Group A
Case 26 Rockboro Group A
Case 26 Rockboro Group A
Corporation
Group A
Piyakul Phewsinual G6149010
Arjachita Suttinun G6149019
Nattawut Vacharanukrauh G6149041
Wiput Thongsuk G6149045
Content
• Case Background
• Suggest Questions
Case Background
Case Background
• In mid-September 2015, Sara Larson, the
chief financial officer (CFO) of a large
computer-aided design and manufacturing
(CAD/CAM) equipment manufacturer
needed to decide whether to pay out
dividends to the firm’s shareholders or to
repurchase stock. If Larson chose to pay
out dividends, she would have to also
decide upon the magnitude of the payout.
A secondary question was whether the
firm should embark on a campaign of
corporate-image advertising and change
its corporate name to reflect its new
outlook.
Case information
Suggest
Questions
Suggest Questions
1. What are the problems here, and what do you recommend?
The problems of Rockboro are;
– Lower the dividend payout ratio to 20%
– Share repurchased
– Imaged advertising and name change campaign
• Based on the theory and the case information; I would recommend to lower dividend payout
to 20% since keep paying too high dividend during the firm expansion and cost overrun from
investment would double the company cost of capital as firm need to borrow to payout
dividend. Also keep paying dividend even at least lower ratio still maintain Rockboro board’s
commitment to pay dividends and comprise strategy for investors who want to receive
dividends and who want to see growth. These also balance the financial needs and
disbursement of free cash flow.
• I also recommend Rockboro to take imaged advertising and name change campaign since I
would help company to be more success in repositioning. By changing their company name
would signal to shareholders that company commit to future growth and international
expanding strategy. Also implies the company’s business really change from the traditional
machine tool to CAD/CAM.
• However, I’m not recommend Rockboro’s CFO to repurchase stock as it would break dividend
commitments and lost the debt capacity flexibility.
Suggest Questions
2. 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’s management willing to vary, and which elements
remain fixed as a matter of the company’s policy?
• It is clear that Rockboro, as a matter of company priority wants to increase per share value to
shareholders. It is also quite clear the company’s goal is to pay a dividend (this is highlighted
throughout the case and in Rockboro’s letter to shareholders stated the intend to resume the
dividend payout in 2015. Another issue that is clear about Rockboro is that the organizational
culture is one that adverse to debt. The cap the company has imposed is 40%; this means the
debt to equity ratio is never to exceed 40%. In 2014 when the company had to borrow funds
externally in order to pay a dividend the debt level rose to 28% and the case indicates that it
was an issue discussed often in meetings and is still a issue of discussion among the
company’s older executives.
• In light of the company’s sensitivity to debt (fixed element) I considered it as an unlikely
source of funds to finance the 2015 dividend they promised. Although a 2015 dividend was
promised it does not mean that a stock buyback is out of the question or off the table.
However, each option requires an additional source of funds.
Suggest Questions
2. 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’s management willing to vary, and which elements
remain fixed as a matter of the company’s policy?
• According to the article “What Do We Know About Stock Repurchases,” financial economists
state that corporate managers use repurchases to “signal” their optimism about the firm’s
prospects to the market. Overall the consensus seems to be that managers often say that
they are repurchasing stock in order to increase earnings per share. However, the authors
propose that this assumption is flawed and that shrinking the size of a firm only adds value if
the firm is failing to earn its cost of capital on their marginal investments. In light of this
article it is unfortunate that the case does not address the discount rate or cost of capital.
• The case explicitly states that Rockboro prefers equity to debt financing so it is reasonable to
assume that they initially would seek to issue more stock to finance the dividend versus
borrowing. The company is also very committed and optimistic about its new Artificial
Intelligent Workforce (AIW) and it is highly unlikely that fewer investments at this point will
be a chosen option. Based on the companies favored approach in the past, in theory they’re
likely to issue stock (this is based on past assumptions and does not analyze the signaling
consequences of such a decision).
Suggest Questions
3. What are the implication of different payout levels for Rockboro’s capital
structure and unused debt capacity?
• It presents financial implications of high dividend payouts which particularly consume unused
debt capacity as the company have to borrow more debt to payout dividend. Also because of
the cyclicality of demand or overruns in investment spending, some attention might be given
to a sensitivity analysis cast over the entire 2015-2021 period as seen in exhibit 26.8.
• Further, unused debt capacity implies Rockboro has inflexibility of raising funds by debt
financing and also respond to existing debt, in other words the firm with unused debt
capacity also caused by insufficient cash flow to payback their upcoming debt repayment.
Suggest Questions
3. What are the implication of different payout levels for Rockboro’s capital
structure and unused debt capacity?
uggest Questions
• 4. What happens to Rockboro’s financing need and unused debt capacity
if:
a) No dividends are paid
Disclosure
The model we use to demonstrate
each scenario in this item is based
on adjusted model of provided
projection of exhibits 26.8.
In case
40% Payout - This would restore the firm to their - Rockboro would fail to meet its targeted
typical dividend payout, thus could lead capital structure with D/E ratio exhibited
positive response to the investor. to excess 40%, according to the
simulation in item no.4.
- At this payout rate will align with the
market practice with average rate - The higher debt borrowing may cause the
payout by the players in the related company entered into liquidity issue.
industry.
- The approach is inconsistent with
- Given the firm has to borrow funds company growth strategy.
from negative cash flow, the firm will
benefit from tax reduction, and
meanwhile bear lower cost of debts.
Residual Payout - The firm’s dividend is subjected to - The dividend payment is unpredictable.
investment in the project with high Some years, Rockboro cannot manage to
NPVs, therefore this would allow the payout any sum. Following this, this
firm to achieve greater return rate. approach may put pressure on the firm’s
- Paying dividend with leftovers would share price.
indicate bank’s preference since
Rockboro’s most of fund are committed
to utilize to support own growth,
making this strategy low debt.
Suggest Questions
6. How might Rockboro’s various providers of capital, such as its
stockholders and creditors, react if Rockboro declares 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?
The zero-dividend payout company will have higher price because it will have higher growth
from higher remained earning and the company can use the fund from equity to reinvest
which leads to higher growth because less cost of debt while the high-dividend payout stock
has lower growth because it has lower parts of equity to reinvest and need to use the
funding from debt.
The type of investment who owns the zero-payout stock are mostly value investments who
expect to invest in long-term and gain capital gain while those who invest in higher-payout
stocks are expect the constant cashflow and not expect for capital gain.
Suggest Questions
10. How might various providers of capital, such as stockholders and
creditors, react if Rockboro repurchased its shares? Should Rockboro
institute a share-buyback plan?
Buying back shares would be implied as the stock price is now undervalued so the
stock price could be higher since the Earning per share will be increases from
lower number of shares and the price of stock will be higher.
However, in the eyes of creditor, they would see the company as it has higher risk
because rather to hold excess cash for future unexpected event or reinvest for
higher growth in the future, the company use the money to buy back the share
and hold less liquidity.
The decision on whether to buy back stock should be that, if the intrinsic
value of the company is greater than its current share price, the shares should be
repurchased.
Suggest Questions
11. Should Larson recommend the corporate-image advertising
campaign and corporate name change to Rockboro’s directors? Do
the advertising and name change have any bearing on the dividend
policy or the stock-repurchase policy that you propose?
Now no advertising campaign alone can change a company’s earnings or growth. What is
important is Rockboro’s ability to communicate to investors, market analysts, etc. what kind
of firm it wants to be. That’s the precipice of marketing, effectively positioning your company
in the eyes of your target market.
Repositioning a firm that has already had an established place or reputation in the market
can be difficult but if the new product and related applications are as good as management
says they are then a well place corporate-image advertising campaign can be successful in
helping the company achieve the desired position they wish to hold with investors and
analysts.
This campaign does not directly affect the proposed dividend payout policy but it could
support it. Successfully repositioning the company can allow or help investors and the
market see why a lower dividend is not a bad signal but in keeping with the company’s new
position as a high growth advanced technological company.