In 2010, the Keenan Company paid dividends totaling $3.6 million on net income o

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 tis previous 10% growth rate. Keenan

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. 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.

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