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

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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.

5 One way to value a share of stock is the dividend growth, or growing perpetuity, model. Consider the following: The dividend payout ratio is 1 minus b, where b is the “retention” or “plowback” ratio. So, the dividend next year will be the earnings next year, E1, times 1 minus the retention ratio. The most commonly used equation to calculate the sustainable growth rate is the return on equity times the retention ratio. Substituting these relationships into the dividend growth model, we get the following equation to calculate the price of a share of stock today:

What are the implications of this result in terms of whether the company should pay a dividend or upgrade and expand its manufacturing capability? Explain.

6Does the question of whether the company should pay a dividend depend on whether the company is organized as a corporation or an LLC?

Explanation / Answer

Q5: This equation is based on the dividend growth model for the stock price is equal to next year's dividend divided by R-G. G represents dividend growth which is equal to plow back ratio X return on equity. Hence higher the plowback, lower will be the price of the shares because investors value shares on the basis of expected dividends. This is true unless the company uses the retained funds for expansion in such a way that it yields a high rate of return on investment in which case the Price of shares will not be much affected.

Q6: The structure of the company whether corporation or LLC does not impact the payment of dividend. An LLC can distribute earnings to its owners in the form of distribution to partners. It is not called dividend as in the case of a corporation but is still an appropriation of the profits.

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