21-4. Firm QTP currently has sales of $10 million with an asset base of $25 mill

Question

21-4. Firm QTP currently has sales of $10 million with an asset base of $25 million. QTP has no accounts payable, a net profit margin of 10%, and a dividend payout ratio of60%. funds required? Assuming that QTP now has accounts payable of $0.5 million, what is the EFR? In addition to having these accounts payable, QTP decides to cut its dividend, making the dividend payout ratio equal to 45%, what then is the associated EFR? Based on the signaling model of dividends (see Chapter 15), should QTP increase or decrease the dividend to indicate its new plan of sales expansion? If QTP decides to increase sales by 20%, then what is the effect on external

Explanation / Answer

EFR = ($25 million ÷ $10 million)*(20%*$10 million) - $0.00 – 10%*$10 million*(1 + 20%)*(1 – 60%) = $4.52 million

EFR with accounts payable = $4.52 million – ($0.5 million ÷ $10 million)*(20%*$10 million) = $4.42 million

EFR with accounts payable and reduced dividend = ($25 million ÷ $10 million)*(20%*$10 million) - ($0.5 million ÷ $10 million)*(20%*$10 million) – 10%*$10 million*(1 + 20%)*(1 – 45%) = $4.24 million

Based on the signaling model of dividends, QTP should increase the dividend to “signal” the expansion to the public.

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