Electronic Timing, Inc. (ETI), is a small company founded 15 years ago by electr

Question

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 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. Several other individuals, including current employees, own the remaining company shares.

Recently, the company designed a new computer motherboard. The company’s new design is both more efficient and less expensive to manufacture, and the ETI design is expected to become standard in many personal computers. After investigating the possibility of manufacturing the new motherboard, ETI determined that the costs involved in building a new plant would be prohibitive. The owners also decided that they were unwilling to bring in another large outside owner. Instead, ETI sold the design to an outside firm. The sale of the motherboard design was completed for an aftertax payment of $30 million.

4.Another option discussed by Tom, Jessica, and Nolan would be to begin a regular dividend payment to shareholders. How would you evaluate this proposal?

Explanation / Answer

Let us understand first the capital structure of the company:

Total outstanding common shares: $1m

Share holding pattern: 75% of shares held by 3 promoters (25% each)

                                                Balance 25% shares held by retail investors.

Let us go through why a company should not pay dividends:

                When a company is in a growth phase, it requires lot of funds to fuel the growth. Procuring funds from external sources may be expensive and would also increase the financial leverage & Debt equity ratio of the company. Hence, usually the companies in growth phase will reinvest the funds within the company and use the internal accruals for further expansion. This will in turn generate more profit and ultimately increase the share holders’ wealth.

The company is in growth phase which is evident from the following;

It has recently entered the market for frequency timing generators,

Its clock products are expanded to include usage in mother boards, peripheral devices & other digital consumer electronics. It has also entered in designing & developing custom application specific integrated circuits for Industrial customers. Recently too, the company had developed a design for manufacturing new motherboard which could not be implemented into commercial production due to lack of investments.

On the other hand, paying dividend provides certainty about the company’s wellbeing. Consistent dividend payments would have favorable effect on a company’s share price.

Hence it is suggested that it can retain major portion of profits generated and pay consider paying dividend for a nominal amount.

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