Analysis of South Eastern Still Company’s Growth and Financing Options

Case Study

            Obviously, South Eastern Still Company (SSC) had grown over the past five years using new process developed by the SSC founders Donald Brown and Margo Valencia. It was not clear weather SSC’s growth target meant of a business expansion or simply the original target growth set by the company through its long-range business plan. It appeared that SSC is doing well; I believed that a healthy growing business does not need outside capital as using outside equity capital is costly.  Outside equity capital providers will demand about profit sharing and control issues, as they will be co- owners of the company, thus, unless the company expansion necessitates outside capital, equity capital may be needed.

Distribution policy is the distributions of investment profits such as dividends and interest gained and net received short-term capital to avail of favorable tax treatment. This policy requires the Southern Steel Company to distribute all of its investment earnings and the yearly net realized long-term capital gains.

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Since the SSC is now open for public offering to collect interest free money coming from the investors, there are considerations that the company must now meet head-on. Bird in the hand is the shareholders decision to prefer certain dividend stream to retained high earnings. In this theory, the investors see dividends as less dangerous than prospective future capital earnings, so they would naturally favors the payment of dividends. Tax preference is the tax-retained earnings that lead to long-term capital earnings, which are taxed. In this case, the investors prefer firms with low tax payout, thus, they would favor the retention of the payment of their dividends. The Dividend irrelevant theory on the other hand, is the investors’ indifference between dividends and retention-generated capital gains. Thus, the investors can create their own dividend policy. In this case, if they opt for cash, they can trade their stocks, however, if do no want cash; they can buy more stock using their dividends.

The management actions that these three theories indicate with respect to dividends payout is that the company will be oblige to set amounts for such financial obligation with particular consideration on the investor’s preference. Regardless of which of the three theories is preferred by the company, the investor’s preference pose as a challenge to the management just as stated earlier in this paper.

The results of the empirical studies of the dividend theories produced a more specified, clearly organized company options on paying dividends to investors. Although investors controlled much of the dividend issue, yet they are important component towards achieving the target growth of the company. These empirical theories provide investors dividends distribution option in a way that the company portfolio is not affected by such profit sharing.

The information content or the signaling of the theory of dividends provides clear measures or options about profit sharing that is both beneficial to the investors and the company. First, it provides the investors an idea what to do with his investment returns, Second, it gives the company the idea of strategic action which makes smoother operation in relation with the investors. The clientele effect of those theories is that it gives a perception of a vibrant firm that is keen on its future capital gains. The effect of these theories to the distribution policies is a more organized, clear pattern of profit sharing. It also provide important idea how much to pay out, when and how such payment are to be made, when to change the amount. In other words, it gives an idea of the right timing of the payment.

Based on the residual model approach, the total capital budget of $800,000 sixty percent equity and forty percent debt with a forecasted net income of 600,000 of this, based on Residual Distribution Model, 480, 000 will be the equity to make the target capital structure 0.6(&800,000), while &320, 000 will be debt 0.4($800,000). With $600,000 net income, the total dollar distribution is $600,000 - $480,000= &120,000 for total distribution. If the net income were forecasted at $400,000, the dividend would be nothing, as the equity will stand out.

 The change in investment opportunities will affect the payout ratio through an increase or decrease of investment opportunities in the sum of equity needed consequently in the residual dividend payout. The advantages and disadvantages of the residual policy is that the company can maximize the use of lower cost retained earnings. In addition, it can avoid negative signals associated with stock. The signal that this will send to clientele depends on proper application of the residual policy. The signaling and clientele effect may lead to higher equity, which would affect the lower floatation cost.

With all these measures in place, the SSC is on the right perspective towards becoming a very competitive business entity given the fact that all the aspect of business details has been strategically addressed through analysis of the investors and clientele impact on the business. I therefore recommend that to Mr. Donald Brown and Mr. Margo Valencia to go on with their plan to secure outside equity capital to address their financial needs for their growing business.

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