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
share). However, this presents no real cause for concern. Furthermore, the firm only has $35 million
in cash and marketable securities at year-end 2015, but that also should not be a problem.
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 …………………………………………………………………………………
Excess funds ………………………………………………………………………………………………………..
2. To determine the number of shares that can be repurchased with $30 million, you first must determine
the market price of the stock.
Earnings per share ……………………………………………..
$1.06
Price-earnings ratio …………………………………………….
x 7
Stock price ………………………………………………………..
$7.42
By dividing $30 million by $7.42, we see that 4,043,127 shares can be repurchased.
3. The earnings are $106,000,000
4.
Earnings per share …………………………………………………………………………………………………..
$1.10
Price-earnings ratio …………………………………………………………………………………………………
x 10
Stock price……………………………………………………………………………………………………………..
$11.00
5.
Stock price……………………………………………………………………………………………………………..
$11.00
Option price……………………………………………………………………………………………………………
– 5.00
Profit per share ……………………………………………………………………………………………………….
$6.00
Shares ……………………………………………………………………………………………………………………
x 50,000
Total before tax profit ……………………………………………………………………………………………..
$300,000
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
might represent the current upside potential for the stock for now. Actually investors are getting