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Gainesboro Machine Tool Corp. – Case XXVI

1. 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 Gainesboro’s management willing to vary, and which
elements remain fixed as a matter of the company’s policy?
2. What happens to Gainesboro’s financing need 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 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% of the book value of equity.
3. How might Gainesboro’s various providers of capital, such as its
stockholders and creditors, react if Gainesboro declares a dividend in
What are the arguments for and against the zero payout, 40% payout,
and residual payout policies?
What should Ashley Swenson recommend to the board of directors with
regard to a long-term dividend payout policy for Gainesboro?
4. How might various providers of capital, such as stockholders and
creditors, react if Gainesboro repurchased its shares? Should Gainesboro
do so?
5. Should Swenson recommend the corporate-image advertising campaign
and corporate name change to the Gainesboro’s directors?
Do the advertising and name change have any bearing on the dividend
policy or the stock repurchase policy that you propose?

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