Alternative dividend policies In 2011 the Keenan Company paid dividends totaling

Question

Alternative dividend policies

In 2011 the Keenan Company paid dividends totaling $2,390,000 on net income of $20 million. Note that 2011 was a normal year and for the past 10 years, earnings have grown at a constant rate of 6%. However, in 2012, earnings are expected to jump to $34 million and the firm expects to have profitable investment opportunities of $14.2 million. It is predicted that Keenan will not be able to maintain the 2012 level of earnings growth because the high 2012 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2012, the company will return to its previous 6% growth rate. Keenan's target capital structure is 40% debt and 60% equity.

Calculate Keenan's total dividends for 2012 assuming that it follows each of the following policies: (Write out your answers completely. For example, 25 million should be entered as 25,000,000.)

Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.
$  

It continues the 2011 dividend payout ratio. Round your answer to the nearest cent.
$  

It uses a pure residual dividend policy (40% of the $14.2 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent.
$  

It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy. Round your answer to the nearest cent.

Which of the preceding policies would you recommend?
-Select-Policy 1Policy 2Policy 3Policy 4Item 6

Assume that investors expect Keenan to pay total dividends of $7,000,000 in 2012 and to have the dividend grow at 6% after 2012. The stock's total market value is $230 million. What is the company's cost of equity? Round your answer to two decimal places.
%

What is Keenan's long-run average return on equity? [Hint: g = Retention rate x ROE = (1.0 - Payout rate)(ROE).] Round your answer to two decimal places.
%

Does a 2012 dividend of $7,000,000 seem reasonable in view of your answers to parts c and d? If not, should the dividend be higher or lower?
-Select-yesno, it should be lowerno, it should be higherItem 9

Explanation / Answer

Policy 1 Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.

Keenan Company 2011 dividend $2,390,000

earnings have grown at a constant rate of 6%

2011 dividend payout $2,390,000 * (1 + g) =$2,390,000 *1.06 =2,533,400

Policy 2 It continues the 2011 dividend payout ratio

Dividend Payout Ratio2011= 12 % = 2390000/ 20000000

Net Income2012= $ 34,000,000

Dividend Payout shall be $ 34,000,000*12% = 4,080,000

Policy 3 It uses a pure residual dividend policy (40% of the $14.2 million investment is financed with debt and 60% with common equity).

Investment    14,200,000

Equity   Portion                 14200000*.60 =8,520,000

Residual income left after financing of project 34,000,000-8,520,000 =25,480,000

Policy 4 It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy.

Regular-dividend

$  2533400

Extra dividend

$22,946,600  

Extra dividend =$ 34000000-$2533400-$8520000

The company could adopt policy 4 by mentioning that the extra dividend this year will not be available in the coming years because this is due to significant increase in profits due to introduction of the new product line but if company seeks other profitable investment that could increase future earnings so it can pay its regular dividend and could invest in those projects but all this will be depend and on the attitudes of share holders of the company because some shareholders prefer

cash dividend while other likes retention to invest in profitable projects in order to increase the returns in future so they could get returns through capital gains

Regular-dividend

$  2533400

Extra dividend

$22,946,600  

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.