微信扫一扫
实时资讯全掌握
| Atrax Corporation is now a diversified company that was originally founded as a textile and milling company by Adam Traxal. During the 1980s and early 1990s before any diversification, Atrax’s earnings had leveled off to about $2.25 per share. The growth possibilities in this industry were limited so that the demand for expansion funds has been low. There were large internal cash flows during this period, and Atrax regularly paid out 65% of its earnings as cash dividends. By the middle 1990s, this large dividend payout had become a trademark of Atrax’s common stock. The firm began diversifying into high-technology, growth companies in 1994 in an effort to reduce its business risk from its dependence on a single source of sales. Traxal thought such diversification was essential to maintain Atrax’s financial health. The diversification program has been successful as far as Traxal is concerned. Atrax is no longer completely dependent on a single source of sales. The earnings have grown moderately to $2.80 per share since 1994 despite the issuance of additional common shares. The price of the Atrax common stock has increased so that the P/E ratio is slightly higher than it was in 1994. In addition, the 65% cash dividend payout ratio has been maintained during the expansion period. The diversification program at first was easily financed by the excess funds that were generated internally. Eventually though, the firm began to recognize the need to use external sources—long-term debt and/or additional issues of common stock—to finance its expansion programs. One consequence of the several common stock offerings was to dilute Traxal’s control over the firm because he was unable to purchase his pro rata share of the additional offerings due to a shortage of personal funds. The Traxal family holdings amounted to 54% of the firm’s stock in 1994 but their ownership has now fallen to around 35%. However, Traxal is still able to maintain effective control over the firm because no other stockholder owns more than 4% of the total stock. Traxal believes that continued expansion is important for Atrax. Traxal is against any additional issues of common equity because he still cannot generate the personal funds necessary to purchase additional stock to maintain his present equity position. However, further expansion could be greatly hampered if additional issues of common equity are not employed. Traxal has instructed his staff to suggest alternative proposals which would allow him to maintain control of Atrax and still continue the firm’s diversification program. A summary of three proposals follow. Proposal 1 The acquisition program would continue and be financed out of earnings not paid out as dividends and from long-term debt issues and preferred stock issues. The current 65% cash dividend payout ratio would be maintained, and there would be no additional issues of common stocks. However, there would be an increase in long-term debt and preferred stock issues. Proposal 2 The acquisition program would continue, and cash dividends would be reduced. The staff estimates that acquisitions could be financed with internally generated funds and a minimum amount of long-term debt. No additional common equity would be required. Atrax could probably distribute cash dividends equal to 10%-20% of earnings. This proposal would not significantly change Atrax’s present debt to equity relationship. In an attempt to appease stockholders who face a drop in their cash dividends, a stock dividend would be paid. Proposal 3 The acquisition program would continue and be financed entirely by internally generated funds by reducing the cash dividend payout rate to zero, if necessary. No additional long-term debt or shares of common stock would be employed. Questions A. Adam Traxal finds Proposal 1 interesting but wonders what effect this would have on the rest of the firm and on the market value of Atrax Corporation’s common stock. Assuming that the price of a firm’s stock is the product of its current earnings per share and its historical price-earnings ratio, indicate the ways in which implementing Proposal 1 would operate to affect the market price of Atrax’s common stock. B. Adam Traxal considers Proposal 3 to be the least attractive because cash dividends might be reduced to zero. Explain what the probable short-term and long-term effects would be on the market price of Atrax’s common stock if the acquisition program is dependent upon reducing the cash dividend payout ratio to zero. C. Adam Traxal considers Proposal 2 the most appealing because dividends would still continue to be distributed. 1. Would Traxal be able to maintain his current equity position of 35% if stock dividends were distributed? Explain your answer. 2. Explain how, if at all, the market price of Atrax’s common stock would probably be affected if this proposal is adopted. 3. Compare and contrast Proposal 2 with Proposal 3 in terms of the probable effects on the market price of Atrax’s common stock. |