Gainesboro Machine Tool Corporation
INDIAN INSTITUTE OF MANAGEMENT, INDORE
Finance 2
Case Analysis
Gainesboro Machine Tool Corporation
Course Instructor: Prof A Kanagraj
Submitted By: Amol Vyawahare
Roll Number: 2008PGP021B
Gainesboro Machine Tool Corporation
Background Reading:
Once a company makes a profit, they must decide on what to do with those profits. They could continue to retain the profits within the company, or they could pay out the profits to the owners of the firm in the form of dividends. Once the company decides on whether to pay dividends, they may establish a somewhat permanent dividend policy, which may in turn impact on investors and perceptions of the company in the financial markets. What they decide depends on the situation of the company now and in the future. It also depends on the preferences of investors and potential investors.
Dividends are payments made to shareholders from a firm's earnings, whether those earnings were generated in the current period or in previous periods. It is a portion of the corporate profit. The dividend is most often quoted in terms of the dollar amount each share receives (dividends per share). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield.
Dividends may affect capital structure.
• Retaining earnings increases common equity relative to debt.
• Financing with retained earnings is cheaper than issuing new common equity.
There are various theories that try to explain the relationship of a firm's dividend policy and common stock value:-
Dividend Irrelevance Theory
This theory purports that a firm's dividend policy has no effect on either its value or its cost of capital. Investors value dividends and capital gains equally.
Optimal Dividend Policy
Proponents believe that there is a dividend policy that strikes a balance between current dividends and future growth that maximizes the firm's stock price.
Dividend Relevance Theory
The value of a firm is...
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