14-10 Alternative Dividend Policies Boehm Corporation has had stable earnings gr
ID: 2720304 • Letter: 1
Question
14-10 Alternative Dividend Policies
Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and 2013 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are expected to jump to $12.6 million and Boehm plans to invest $7.3 million in a plant expansion. This one time unusual earnings growth wont be maintained though and after 2014 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%.
a. calculate Boehms total dividends for 2014 under each of the following policies:
(1) its 2014 dividend payment is set to force dividends to grow at the long-run growth rate earnings.(Answer is $2,88,000--show work and formulas to support answer.)
(2) It continues the 2013 dividend payout ratio (Answer is $3.34 Million--show all work and formulas to support answers)
(3) It uses a pure residential policy with with all distribution in the form of dividends (35% of the $7.3 million investment is financed with debt) (Answer is $7,855,000--show all work and formula to support answer)
(4) It employs a regular dividend plus extra policy with the regular dividend being based on the long run growth rate and the extra dividend being set according to residual policy. (Answer is Regular = $2,808,000; Extra = $5,047,000--show all work and formulas to support answers)
b. Which of the preceding policies would you recommend? Restrict your choices to the ones listed but justify your answer.
c. Does a 2014 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 2014 dividend payment is set to force dividends to grow at the long-run growth rate earnings
Boehm's Table earning growth rate 8%
Boehm's 2013 Dividend amount $ 26,00,000
Dividend for 2014 $26,00,000 * 1.08 = 28,08,000
2. It continues the 2013 dividend payout ratio
Net Income in 2013 $98,00,000
Dividend Paid in 2013 $26,00,000
Dividend payout ratio 26,00,000 / 98,00,000 *100 = 26.53%
Net Income in 2014 $126,00,000
Dividend for 2014 126,00,000 * 26.53% = $33,42,857
3. It uses a pure residential policy with with all distribution in the form of dividends (35% of the $7.3 million investment is financed with debt)
Cost of plan expansion $73,00,000
Equity Finance (100%-35%) 65%
Required Equity Finance $47,45,000
Net Income of 2014 $126,00,000
Dividend = net Income-
Equity Financed $78,55,000 ( $126,00,000 - 47,45,000)
4. It employs a regular dividend plus extra policy with the regular dividend being based on the long run growth rate and the extra dividend being set according to residual policy.
Dividends required by residual policy (calculated in No. 3 above) $78,55,000
Regular dividends based on long-run growth rate (1.08% times $2013 dividend) $30,24,000
Extra dividend ( $78,55,000 - $30,24,000 ) $48,31,000
b. Company should actally have a reasonble retention and distrubution policy for dividend distribution. Since in pure residential policy with with all distribution in the form of dividends and in regular dividend plus extra policy is higher than the first two options in shareholders interest the company may resort to either of these options. Against this, in option 2, the retention ration is much more than payout ratio which may be good policy if the company is looking for expansion projects etc.
c. $90,00,000 dividend means a payout ratio of approx. 71.5% means company only retains 28.5% profits fas funds which may be too less in case the company desires to expand. In my opinion, dividend should be lower or reasonable enough to safegaurd the short term interest of the investors as well as take care of the long term investment plans of the company.
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