Problem
I. 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 these three elements is Eastboro management willing to vary, and which elements remain fixed as a matter of policy?
II. What happens to Eastboro's financing need and unused debt capacity if
i. No dividends are paid?
ii. a 20 percent payout is pursued?
iii. a 40 percent payout is pursued?
iv. a residual payout policy is pursued?
Note that case Exhibit 8 presents an estimate of the amount of borrowing needed. Assume that maximum debt capacity is, as a matter of policy, 40 percent of book value of equity.
III. How might Eastboro's various providers of capital, such as stockholders and creditors, react if Eastboro declares a dividend in 2001? What are the arguments for and against the zero payout, 40 percent payout, and residual payout policies? What should Jennifer Campbell recommend to the board of directors with regard to a long-run dividend payout policy for Eastboro Machine Tools Corporation?
IV. How might various providers of capital, such as stockholders and creditors, react it Eastboro repurchased shares? Should Eastboro do so?
V. Should Campbell recommend the corporate-image advertising campaign and corporate name change to the directors? Do the advertising and name change have any bearing on the dividend policy or stock repurchase policy you propose?