In 2010, the Keenan Company paid dividends totaling $3.6 million on net income o
ID: 2669868 • Letter: I
Question
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—the high 2011 projected earnings level is due to an exceptionally profitable 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)Its 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 uses 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 rate 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?
Explanation / Answer
1. Its 2011 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
3.6*1.1 = 3.96 million dollars
2. It continues the 2010 dividend payout ratio.
3.6/10.8*14.4 = 4.8 million dollars
3. It uses a pure residual policy with all distributions in the form of dividends (40% of the $8.4 million investment is financed with debt.)
14.4-8.4*.6 = 9.36 million dollars
4. It employs a regular-dividend-plus-extra’s policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy.
14.4-4.8-8.4*.6 = 4.56+4.8 = 9.36 million dollars.
Which of the proceeding policies would you recommend? Restrict your choices to the ones listed, but justify your answers.
The company should distribute all earnings as dividend if it has no reason to hold it for future growth therefore 9.36 million dollars seems to be reasonable for the year 2011 as dividend. It will definitely make investors happy and the market price of company shares will go up. But it should be informed to the investor that this is only for this year, as they should not expect the same dividend for the coming years.
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?
Yes it is reasonable, the explanation has been given already.
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