Scottsville Instruments, Inc., (SCII) is a U.S. based company emerging as a leader in providing medical testing equipment to the pharmaceutical and biotechnology industries. SCII’s primary markets are growing and the company is spending $100 million a year on research and development to enhance its competitive position. SCII is highly profitable and has substantial positive free cash flow after funding positive NPV projects. During the past three years, SCII has made significant share repurchases. Subsequent to the reduction in the tax rate on cash dividends to 15 percent in the United States, the same tax rate as that on long term capital gains, SCII management is proposing the initiation of a cash dividend. The first dividend is proposed to be an annual dividend of $0.40 a share to be paid during the next fiscal year. Based on estimated earnings per share of $3.20, this dividend would represent a payout ratio (DPS/EPS) of 0.125 or 12.5 percent. The proposal that will be brought before the board of directors is the following:
Proposed: Scottsville Instruments, Inc., will institute a program of cash dividends. The first dividend will be an annual dividend of $0.40 a share, to be paid at a time to be determined during the next fiscal year. Thereafter, an annual dividend will be paid consistent with retaining funds sufficient to finance profitable capital projects.
The company’s board of directors will formally consider the dividend proposal at its next meeting in one month’s time. Although some directors favor the dividend initiation proposal, other directors, led by William Marshall, are skeptical of it. Marshall has stated:
“The initiation of a cash dividend will suggest to investors that SCII is no longer a growth company.”
As a counterproposal, Marshall has offered his support for the initiation of an annual 2 percent stock dividend. Elise Tashman, a director who is neutral to both the cash dividends and stock dividend ideas, has told Marshall the following:
“A 2 percent stock dividend will not affect the wealth of our shareholders.”
presents selected pro forma financials of SCII, if the directors approve the initiation of a cash dividend.
Scottsville Instruments, Inc., Pro Forma Financial Data Assuming Cash Dividend ($ millio
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Income Statement |
Statement of Cash Flows |
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|
Sales |
$1,200 |
Cash flow from operations |
$135 |
|
Earnings bcforc taxes |
155 |
Cash flow from investing activities |
(84) |
|
Taxes |
35 |
Cash flow from financing activities: |
|
|
Net income |
120 |
Debt repayment |
(4) |
|
Share repurchase |
(32) |
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|
Proposed dividend |
(15) |
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Estimated change in cash |
0 |
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Ratios |
Five Year Forecasts |
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|
Current ratio |
2.1 |
Sales growth |
8% annually |
|
Debt/equity (at marker) |
0.27 |
Earnings growth |
11% annually |
|
Interest coverage |
10.8x |
Projected cost of capital |
10% |
|
ROA |
10.0% |
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|
ROE |
19.3% |
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|
PIE |
20x |
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|
E/P |
5.0% |