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Orbit Chemical Company Case 29
Dividend Policy
Purpose: This case has a completely different emphasis from the prior dividend case, Montgomery
Corporation. The Orbit Chemical Company case stresses the critical emphasis of the statement of cash
flows in determining whether a company has the ability to make dividend payments. The emphasis is
away from the relation of earnings to dividends, and toward the importance of cash flow. It truly forces
the student to do insightful financial analysis, as the answer to question one is not obvious. Some
instructors may want to give clues to help the students. There is also an interesting side issue related to
the repurchase of shares in the open market, and the associated impact on earnings per share and stock
price. Executive stock options are also included in the analysis.
Relation to Text: This case should follow Chapter 18.
Complexity: The case is moderately complex. It should require 45 minutes.
Solutions
1. If the student properly analyzes the financial statements, he or she will see there is no need to reduce
the cash dividend.
The dividend payout ratio is relatively high at 61.3% ($.65 dividends per share/$1.06 earnings per
The real key to the analysis can be found in Figure 3, the statement of cash flows. Here, we see the
Net income plus depreciation................................................................................................ $166 million
The firm could not only cover the dividends, but use the excess funds (a term roughly the equivalent
to free cash flow) to almost double the dividend.
The problem was that Robert Osborne had used these funds and part of a high beginning cash balance
to reduce $120 million of long-term debt that was not due until 2028 (see financing activities under
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
With $500 million in equity, total debt would have still been less than equity and long-term debt
considerably less.
2. To determine the number of shares that can be repurchased with $30 million, you first must determine
the market price of the stock.
3. The earnings are $106,000,000
The shares outstanding are 100,000,000 – 4,043,127 = 95,956,873
10.1$
873,956,95
000,000,106$
Shares
Earnings
:are shareper earnings Recomputed
4. Earnings per share.................................................................................................................... $1.10
Price-earnings ratio.................................................................................................................. x 10
Stock price................................................................................................................................ $11.00
5. Stock price................................................................................................................................ $11.00
6. The stock market’s reaction is quite likely to be negative to Robert Osborne exercising his options.
By using 50,000 of his options to buy and resell stock now, he is indicating that he thinks $11.00
The insightful investor might ask further questions such as, “Does Robert Osborne have a particular
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
