Reference no: EM131132019
a. Analyze each of the three dividend policies in light of GAC's financial position.
b. Which dividend policy would you recommend? Justify your recommendation.
c. What are the key factors to consider when setting the amount of a firm's initial annual dividend?
d. How should Ms. McNeely go about deciding what initial annual dividend she will recommend to the board?
e. In view of your dividend policy recommendation in part b, how large an initial dividend would you recommend? Justify your recommendation.
General Access Company (GAC) is a fast-growing Internet access provider that initially went public in early 2003. Its revenue growth and profitability have steadily risen since the firm's inception in late 2001. GAC'S growth has been financed through the initial common stock offering, the sale of bonds in 2006, and the retention of all earnings. Because of its rapid growth in revenue and profits, with only short-term earnings declines, GAC'S common stockholders have been content to let the firm reinvest earnings as part of its plan to expand capacity to meet the growing demand for its services. This strategy has benefited most stockholders in terms of stock splits and capital gains. Since the company's initial public offering in 2003, GAC's stock twice has been split 2-for-i. In terms of total growth, the market price of GAC's stock, after adjustment for stock splits, has increased by 800% daring the 7-year period 2003-20 09.
Because GAC's rapid growth is beginning to slow, the firm's CEO, Marilyn McNeely, believes that its shares are becoming less attractive to investors. McNeely has had discussions with her CFO, Bobby Joe Rook, who believes that the firm must begin to pay cash dividends. He argues that many investors value regular dividends and that by beginning to pay them, GAC would increase the demand-and therefore the price-for its shares. McNeely decided that at the next board meeting she would propose that the firm begin to pay dividends on a regular basis.
McNeely realized that if the board approved her recommendation, it would have to
(1) Establish a dividend policy and
(2) Set the amount of the initial annual dividend.
She had Rook prepare a summary of the firm's annual EPS. It is given in the following table.
Years EPS
2009 ......... $3.70
2008 ......... 4.10
2007 ......... 3.90
2006 ......... 3.30
2005 .......... 220
2004 .......... 0.83
2003 .......... 055
Rook indicated that he expects EPS to remain within 10% (plus or minus) of the most recent (2009) value daring the next 3 years. His most likely estimate is an annual increase of about 3%.
After much discussion, McNeely and Rook agreed that she would recommend to the board one of the following types of dividend policies:
1. Constant-payout-ratio dividend policy
2. Regular dividend policy
3. Low-regular-and-extra dividend policy
McNeely realizes that her dividend proposal would significantly affect future financing opportunities and costs and the firm's share price. She also knows that she must be sure that her proposal is complete and that it fully educates the board with regard to the long-term implications of each policy.