Megaware Case StudyMegaware Incorporated is a technology firm that was founded eight
years ago by John Thompson and Jill Dillman. Megaware manufactures
various hardware and software components. Its products are used in
personal computers and other peripheral devices. In addition to John and
Jill, Nick Jones is also an owner of the firm because he provided
capital. Each of the three owns 20 percent of the company. The current
employees own the remaining part of the company. The firm recently developed a new computer hardware component. The
component is supposed to be more energy efficient and less costly to
produce. After investigating the possibility of manufacturing the new
hardware component, Megaware determined that constructing a new plant
would be too costly. John, Jill, and Nick do not want to bring in
another outside investor, so Megaware has decided to sell the hardware
component for an after-tax payment of $42 million.Case Study ProblemsProblem 1. John thinks that the firm should use the
excess cash flow to pay a special one-time dividend to the investors.
How will implementing this proposal affect the value of the company as
well as the stock price? Problem 2. Jill believes that the firm should use
the excess cash flow to pay off debt and expand its manufacturing
capability. How would implementing this proposal affect the company? Problem 3. Nick contends that a share repurchase
will increase the company’s ROA, ROE, and P/E ratio. Do you agree? How
will a share repurchase affect the value of the firm? Problem 4. John, Jill, and Nick have discussed a proposal to commence a regular dividend payment to stockholders. Evaluate this plan. Problem 5. The dividend growth model is used by many
investors to value stock. Calculate the price of a share of Megaware
stock today by using the following dividend growth model equation: P0 = E1(1 − b) / Rs = ROE × b The value of the stock equals next year’s dividends divided by the sustainable growth rate.The dividend-payout ratio is 1 minus b, where b is the retention
ratio. The dividend next year (P0) will be the earnings next year (E1)
times 1 minus the retention ratio: P0 = E1(1 − b).The sustainable growth rate (Rs) is the return on equity (ROE) times the retention ratio: Rs = ROE × b.Based on your results, should Megaware pay a dividend or expand its manufacturing capability? Explain your decision. Problem 6. Does the way a company is organized (as a
corporation, LLC, or another structure) determine whether the company
should pay a dividend?Additional Resources for Further ExplorationThe following texts are designed to assist learners to master core concepts, solve financial problems, and analyze results.Ross, S. A., Westerfield, R. W., Jaffe, J. F., & Jordan, B. D.
(2014). Corporate finance: Core principles and applications (4th ed.).
New York, NY: McGraw-Hill. – Available from the bookstore
Chapter 14, “Capital Structure: Basic Concepts,” pages 423–451.Chapter 15, “Capital Structure: Limits to the Use of Debt,” pages 452–480.Chapter 16, “Dividends and Other Payouts,” pages 481–515.
The text offers an introductory look at corporate finance.Welch, I. (2014). Corporate finance (3rd ed.). Retrieved from http://book.ivo-welch.info/ed3/
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