This question is from Financial Management Theory and Practice 13e, Brigham Ehrh
ID: 2666125 • Letter: T
Question
This question is from Financial Management Theory and Practice 13e, Brigham Ehrhardt, South-Western Cengage Learning
In 2010, the Keenan Company paid dividends totaling $3.6 million on net income of $10.8 million. The year was a normal one, and earnings have grown at a constant rate of 10% for the past 10 years. However, in 2011, earnings are expected to jump to 14.4 million, and the firm expects to have profitable investment opportunities of $8.4 million.
It is predicted that Keenan will not be able to maintain the 2011 level of earnings growth-high 2011 projected earnings level is due to an exceptionally profitable new product new product line to be introduced that year-and then the company will return to its previous 10% growth rate. Keenan’s target debt ratio is 40%.
a.) Calculate Keenan’s total dividends for 2011 if it follows each of the following policies:
1.) It’s 2011 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
2.) It continues the 2010 dividend payout ratio.
3.) It used a pure residual policy with all distributions in the form of dividends (40% of the $8.4 million investment is financed with debt).
4.) It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long run growth and the extra dividend being set according to the residual policy.
b.) Which of the preceding policies would you recommend? Restrict your choices to the ones listed, but justify your answer.
c.) Does a 2011 dividend of $9 million seem reasonable in view of your answers to parts a and b? If not, should the dividend be higher or lower?
Please provide the detailed work behind the answer received.
You should come up with the following answers:
a.
(1). $3,960,000
(2). $4,800,000
(3). 9,360,000
(4). Regular = $3,960,000; Extra = $5,400,000
Explanation / Answer
a) 1) 2008 Dividends = 1.10 (2007 Dividends) = 1.10 ($3,600,000) = $3,960,000 2) 2007 Payout = $3,600,000 / $10,800,000 = 33% 2008 Dividends = (0.33 )(2008 Net income) = 0.33 * ($14,400,000) = $4,800,000 3) Equity financing = $8,400,000 (0.60) = $5,040,000 2008 Dividends = Net income - EQuity financing = $14,400,000 - $5,040,000 = $9,360,000 4) The regular dividends would be 10% above the 2007 Dividends. Regular dividends = (1.10) ($3,600,000) = $3,960,000 Extra Dividend = $9,360,000 - $3,960,000 = $5,400,000 b) POlicy 4, based upon the regular dividend with an extra, seems most logical. Completed properly, it would lead to the correct capital budget and the correct financing of that budget and it would give correct signals to investors. c) No, the dividend of $9,000,000 is not a reasonable when compared to the answers in parts (a) and (b). The Dividends should be lower.Related Questions
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