Question 1 If we take a look at the company’s compounded annual growth rate in EPS we can see that Georgia Atlantic’s growth rate is really low compared to the industry average. Furthermore we can see from the first table that Georgia Atlantic’s P/E ratio is also lower in all the years as compared to the industry and the M/B ratio is also relatively low compared to the industry.
Due to the fact that Georgia Atlantic is operating in a relatively mature market, there is a very low possibility for growth, that’s why we consider Georgia Atlantic as a low growth company. For low growth companies it is normal to have a low P/E ratio and a low B/M ratio because most of the company’s value comes from their current operations and assets. Because Georgia Atlantic is a low growth company they should in fact pay out dividend as is the case for low growth firms. But this is not the case for Georgia Atlantic. Question 2
It might be Best for Georgia Atlantic to have an announced dividend policy because the biggest advantage of having an announced dividend policy is that this will reduce the investors (stockholders) uncertainty, and reductions in uncertainty are associated with lower capitalization rates (required returns) and higher stock prices, other things being the same. The disadvantage to an announced dividend policy is that such a policy might decrease corporate flexibility. However, the announced policy would possibly include elements of flexibility, for example, a regular dividend plus extras.
On balance, it would appear desirable for directors to announce their policies. Question 3 g=ROE(Retention Rate) Most firms payout some of the Net Income as dividends and reinvest, or retain the rest. The payout ratio is the percent of net income that the firm pays out as dividend, defined as the total dividend divided by net income. The retention ratio is the complement of the payout ratio: Retention Ratio= (1- Payout Ratio). ROE is the return on equity, defined as the net income available to common stock holders divided by common equity.
So the growth rate of a firm depends on the amount of net income that it retains and the rate it earns on the retentions. The formula above produces a constant growth rate. But when using it we are making four assumptions: (1) we expect the payout rate and thus the retention rate to remain constant, (2) we expect the return on equity on a new investment to remain constant, (3) the firm is not expected to issue new common stock, or if it does, we expect this new stock to be sold at a price equal to its book value and (4) future projects are expected to have the same degree of risk as the firm’s existing assets.
From the table in question 1, we could see that Georgia Atlantic’s earnings have grown at a slower rate than the industry average earnings. In spite the fact that they have retained all their earnings and never paid any dividends. This results in higher earnings growth from its high retention rate 100%. And because of this Georgia Atlantic’s returns are far below the average of the industry. Question 4 The family’s argument that higher-priced stocks are more attractive because of the lower percentage costs is not valid.
Transaction costs are levied over the total amount of the transaction and not on the basis of the number of shares transacted. The value of the individual shares in a transaction are therefore of little importance to the transaction costs. In fact, it can be argued that an optimal price range for stocks in the lumber industry exists between $20 and $40, although there is only little empirical evidence on whether an optimal price range for stocks really exists. This suggests that if a company’s stock sells in this range, the value of the firm is maximized.
Georgia Atlantic’s stock price of $2000 might deter small investors from investing in the company. A lower share price will definitely be beneficial to investors because it will give them more options to include the Georgia Atlantic shares in their portfolio. Question 5 Financial leverage has a negative impact on dividend payout because it indicates less dividend payments by high-debt firms. Highly levered firms look forward to maintaining their internal cash flow to fulfill duties, instead of distributing available cash to shareholders and protect their creditors.
This is because firms with high leverage ratios have high transaction costs, and are in a weak position to pay higher dividends to avoid the cost of external financing. While firm value can be increased by financial leverage, too much leverage leads to a shrinking company value as bankruptcy costs start to outweigh tax shield benefits. The higher risk makes debt holders asking for higher returns to compensate them for the increase in bankruptcy risk. Since dividend payments reduce the amount of capital available to secure the debt, many debt contracts include restrictions on dividend payments.
Bond indentures restrict dividend payments subject to minimum safety ratios. These two effects, the higher costs of debt and the restrictions to pay dividends have, of course, a direct effect on the company’s ability to pay dividends. The high leverage of Georgia Atlantic, which is well above its industry average, reduces the possibilities for the firm in terms of its dividend policy. Holding Georgia Atlantic’s dividend payout history in mind, it might seem to be a bad time to start thinking about a policy change. Question 6 1) No Cash Dividends, No Stock Dividends or Split
This strategy is not recommendable because firstly the 1992 Market-to-Book value is well below 1, meaning that the company has not invested in any profitable projects anymore. The retained earnings would have generated a higher shareholder value if they would have been paid out to the shareholder. Furthermore the share price of the firm would stay rather constant and would not diverge too much from the optimal range between $20 and $40. A lower share price would also increase the P/E ratio of Georgia Atlantic signaling a healthier company to the market. ) Immediate Cash Dividend, but No Stock Dividend or Split The strategy to pay immediate cash dividends is definitely better to the no cash dividend strategy, because Georgia Atlantic can increase shareholder value much more by paying out dividends than retain its earnings due to the fact that the company can be regarded as a value company with only a few growth opportunities. Still there is the problem that the firm’s stock price is too high. The actual price per share of $1,902 should be lowered to a price as proposed by the managers somewhere in between the range of $20-$40.
Therefore a high stock split is very recommendable. 3) Immediate Cash Dividend plus a Large Stock Split The immediate cash dividend would increase shareholder value while a large stock split would lower the share price significantly to the average price range. To reach a stock price in between $20 and $40 dollars per share, the company has to declare a stock split of maximal 95 to 1 ($20/share) and minimal 48 to 1 ($40/share) meaning that every shareholder gets 95 new shares per share he already holds in the maximal case and gets 48 new shares per share they already own in the minimal case.
A lower share price also would increase the liquidity of the share, because more investors are able to buy at this lower price. 4) Immediate Cash Dividend plus a Large Stock Dividend Leading to almost the same result, the immediate cash dividend together with a large stock dividend is not as recommendable as the third proposal is. Stock dividends are not efficient when one is trying to reduce the share price. They are normally used to maintain the price of a share or to slightly lower it.
So in the case of Georgia Atlantic a stock split might be better than a stock dividend to cut the share price. 5) Cash Dividend, Stock Split, and Periodic Stock Dividends Since Georgia Atlantic is a value-firm, it should really consider paying out a regular cash dividend to its shareholders. Furthermore a stock split would lower the share price and thus makes it possible for more investors to buy a round lot of Georgia Atlantic’s shares. In addition to that, a regular stock dividend assures a rather stable share price. 6) Share Repurchase Plan
This plan would enable Georgia Atlantic to react very flexible to the needs of certain shareholders. Furthermore the capital outlay for the firm is reduced due to the fact that no dividends have to be paid out and no transaction costs for stock dividends occur. Most shareholders would also prefer to hold their shares and not to resell them to the company. Although this plan definitely has some major advantages, it also has some disadvantages. Those investors that still request a regular cash dividend are not going to be pleased. Question 7
Considering Georgia Atlantic? s present financial condition we could say that a hostile takeover is very likely. As mentioned the `breakup value` or the value of the company if it were broken and sold in pieces would be as high as $3500/share because other lumber companies are eager to buy prime properties that Georgia Atlantic owns. This break-up value is higher than the current share price $1902/share. As we have seen in the table at question 1 the 1992 M/B ratio is also quite below one, and a M/B ratio below 1 means that the stock is undervalued.
Taking these factors into consideration one could say that this takeover would be favorable because investors could sell parts of the company in order to get profit. One way to reduce the risk of a hostile takeover attempt might be the sale of some assets by Georgia Atlantic. As they are not using all of their assets efficiently they could sell those assets which they are not using and use the income derived from this to restructure its operations. The downside to this strategy is that those assets that are used inefficiently right now are also the most valuable assets for the company.
Question 8 The estate tax situation should not be brought up because as they mentioned Mr. Jenkins Junior has health issues and they don’t know for how long he is going to live. Keeping this in mind if Georgia Atlantic’s shareholders get to know this information they will definitely sell their stocks, this would lead to a decrease in the share price which will most likely lead to a hostile takeover. ??? Question 9 If we take a look at Georgia Atlantic’s long history of not paying dividends, they probably would have those investors that are interested in capital gains.
Nevertheless, the low number of shareholders that sent in their proxies can be an indication that there is also a large amount of investors that would prefer regular dividend payments. So in the end it is difficult to predict the predominant stockholder clientele. It might be easier to predict the future stockholder clientele if Georgia Atlantic is not changing its dividend policy in time. The investors then might, to a large extent, be competitors or private equity investors attempting a hostile takeover.
Question 10 To increase the liquidity of the stock, Georgia Atlantic should definitely declare a stock split. An optimal price range for a stock in the firm’s industry is somewhere between $20 and $40. Using a conservative price of $29. 71 per share, the company should declare a 64 to 1 stock split. This would result in a stock appreciation if the company can increase earnings and dividends over the next month. In addition to this one time stock split the company should also pay regular stock dividends.
The precise dividend policy is going to be explained later on in this section. While Georgia Atlantic has a large amount of assets, it can only utilize a certain amount of them. The tough financial situation prohibits the company to expand its operations and to use the assets more efficiently. So the most profitable solution would be to sell the underutilized assets to competitors. The amount of assets that should be sold cannot be identified with the given data, but it is reasonable to sell not more assets than are actually needed to keep the operations up.
Since the industry faces a certain maturity, Georgia Atlantic should rather not invest the proceeds from the sale of assets into new production facilities. The company would do better if they use the freed money, together with some retained earnings, to repay some of their debt and reduce the debt-to-capital ratio. This also would reduce the risk of the firm. Over time, since the initial freed up capital might still not be enough, Georgia Atlantic should reach a financial leverage which is comparable to the industry average. The leftover of retained earnings should be used by the firm to pay dividends to the shareholder.
Since the company struggles financially, the initial dividend should be very conservative. As an example, due to the absence of proper data, the company should pay out 10% of its EPS in cash dividends. This would lead to a first cash dividend of $0. 22 for a share price of $29. 71. The very low cash dividend at the beginning can be paid by the company in either situation and shareholders would receive a stable yearly dividend. If the future outlook of the firm improves, this dividend can be increased and the shareholder would see this as a positive signal.
Next to the cash dividend, Georgia Atlantic should also give out stock dividends that are flexible and are of the same percentage than the yearly growth in EPS is. This would lead to a rather stable share price and investors would gain through growth in EPS. To sum up, although the company would shrink due to the sales of assets and would also abandon its three decades old dividend policy, Georgia Atlantic would have the chance to restructure and become an interesting investment opportunity once again. This step would also increase the stockholder loyalty and strengthen the family’s position within the company.