ACC – Electronic Timing, Inc. (ETI)

ETI is a small company founded 15 years ago by electronic engineers Tom Miller and Jessica Kerr. ETImanufactures integrated circuits to capitalize on the complex mixed-signal design technology andhas recently entered the market for frequency timing generators, or silicon timing devices, whichprovide the timing signals or “clocks” necessary to synchronize electronic systems. Its clock productsoriginally were used in PC video graphics applications, but the market subsequently expanded to includemotherboards, PC peripheral devices, and other digital consumer electronics. In addition to Tom andJessica, Nolan Pittman, who provided capital for the company, is the third primary owner. Each owns25 % of the 1 million shares outstanding. The company has several other individuals, including currentemployees, who own the remaining shares.Recently, the company designed a new computer motherboard. The company’s design is both moreefficient and less expensive to manufacture, and the ETI design is expected to become standard inmany personal computers. After investigating the possibility of manufacturing a new motherboard,ETI determined that the costs involved in building a new facility would be prohibitive. The owners alsodecided that they were unwilling to bring in another large outside owner. Instead, ETI sold the designto an outside firm. The sale of the motherboard design was completed for an after-tax payment of $30million.Questions1. Tom believes the company should use the extra cash to pay a special one-time dividend. Howwill this proposal affect the stock price? How will it affect the value of the company?2. Jessica believes the company should use the extra cash to pay off debt and expand and upgradeits manufacturing capability. How would Jessica’s proposal affect the company?3. Nolan favors a share repurchase. He argues that a repurchase would increase the company’sP/E ratio, return on assets, and return on equity. Are his arguments correct? How will a sharerepurchase affect the value of the company?4. Another option discussed by Tom, Jessica, and Nolan would be to begin a regular dividendpayment to shareholders. How would you evaluate this proposal?5. One way to evaluate 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, E 1, times 1 minus theretention ratio. The most commonly used equation to calculate the sustainable growth rate isthe return on equity times the retention ratio. Substituting these relationships into the dividendgrowth 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 dividendor upgrade and expand its manufacturing capability? Explain.