Question

ELECTRONIC TIMING, INC. Electronic Timing, Inc. (ETI), is a small company founded 15 years ago by electronics engineers Tom Miller and Jessica Kerr. ETI manufactures integrated circuits to capitalize on the complex mixed-signal design technology and has recently entered the market for frequency timing generators, or silicon timing devices, which provide the timing signals or "clocks” necessary to synchronize electronic systems. Its clock products originally were used in PC video graphics applications, but the market has subsequently expanded to include motherboards, PC peripheral devices, and other digital consumer electronics, such as digital television boxes and game consoles. ETI also designs and markets custom application-specific integrated circuits (ASICs) for industrial customers. The ASIC's design combines analog and digital, or mixed-signal, technology. In addition to Tom and Jessica, Nolan Pittman, who provided capital for the company, is the third primary owner. Each owns 25 percent of the 1 million shares outstanding. The company has several other individuals, including current employees, who own the remaining shares.

Answer 1

1.

The value of the company will decline by the amount of the dividend. Ignoring taxes, shareholders wealth will not be affected because the stock price will drop by the amount of the dividend payment.

2.

The value of the company could increase or decrease. If the company is over-levered, paying off debt can lower the interest rate on debt, and decrease financial distress costs. If there are no financial distress costs, capital structure theory argues that increasing debt can increase the value of the company because of the interest tax shield.

3.

The PE ratio will fall and the ROA and ROE will increase, but the changes are irrelevant.

4.

A regular dividend payment is something the company should probably not undertake. A company rarely begins regular dividend payments that it will be unable to continue in the future. Cessation of dividend payments is viewed as a negative signal by the market.

5.

The implication is that the company should not retain earnings unless the ROE of the new project is greater than the shareholders required return on equity. This is an intuitive result. Shareholders want the company to retain earnings for future growth if the earnings will earn a greater return than shareholders require. If the return on the retained earnings is lower than shareholders required return, the company is lowering shareholder value.

6.   

The decision does depend on the organizational form of the company. Money paid to shareholders of a corporation are dividends, and currently taxed at the lower dividend tax rate. Money paid to the owners of an LLC is considered income, and taxed at the applicable personal income tax rate.