Chapter 15, Problem 10P

a)

1)

Summary Introduction

To determine: Total dividends of Company B for 2019, when dividend payments forces to grow at long-run growth rate in earnings.

Explanation of Solution

Given statement:

Past 10 year earnings is 8%,

Dividends paid in 2018 is $2.6 million,

Net income $9.8 million,

Earnings are expected to jump $12.6 million in 2019

Debt ratio is 35%

Calculation of total dividends for 2019:

$\begin{array}{c}\text{Total}\text{dividends}=\left(\text{Dividends}\text{in}\text{2018}\right)\left(1+{\text{LT}}_{\text{g}}\right)\\ =\left(\$2,600,000\right)\left(1+0.08\right)\\ =\$2,808,000\end{array}$

Hence, total dividends in 2019 is $2,808,000

2)

Summary Introduction

To determine: Total dividends of Company B for 2019, when it continues the same dividend pay-out ratio of 2018.

Explanation of Solution

Calculation of DPS in 2018:

For calculating total dividends paid in 2019, we must find pay-out ratio of 2018.

$\begin{array}{c}\text{Pay-out}\text{ratio}\text{in 2018}=\frac{\$2,600,000}{\$9,800,000}\\ =0.2653\\ =26.53\%\end{array}$

Therefore, pay-out ratio is 26.53%

Calculation of total dividends in 2019:

$\begin{array}{c}\text{Total dividends}=\left(\text{Pay-out}\text{ratio}\right)\left(\text{Net}\text{income}\text{in}\text{2019}\right)\\ =\left(0.2653\right)\left(\$12,600,000\right)\\ =\$3.34million\end{array}$

Hence, total dividends in 2019 are $3.34 million.

3)

Summary Introduction

To determine: Total dividends of Company B for 2019, when it utilizes pure residual policy in the form of dividends. (35% ($7.3million) financed by debt)

Explanation of Solution

Debt financing is 35% then equity financing is 1-debt financing.

$\begin{array}{c}\text{Equity}\text{financing}=\$7,300,000\left(1-0.35\right)\\ =\$4,745,000\end{array}$

Calculation of total dividends in 2019:

$\begin{array}{c}\text{Total dividends}=\left(\text{Net}\text{income}\text{in}\text{2019}-\text{Equity}\text{financing}\right)\\ =\left(\$12,600,000-\$4,745,000\right)\\ =\$7,855,000\end{array}$

Hence, total dividends in 2019 are $7,855,000

All of the equity finance is completed with re-invested retained earnings as long as they are available.

4)

Summary Introduction

To determine: Total dividends of Company B for 2019, when it uses regular dividend plus extras policy, regular dividend founded on long run growth and extras on residual policy.

Explanation of Solution

Regular dividends would be 8% above the 2018 dividends.

$\begin{array}{c}\text{Regular dividends}=\left(1.08\right)\left(\$2,600,000\right)\\ =\$2,808,000\end{array}$

The residual policy calls for $7,855,000. Therefore, the extra dividends would be,

Calculation of extra dividends:

$\begin{array}{c}\text{Extra}\text{dividends}=\$7,855,000-\$2,808,000\\ =\$5,047,000\end{array}$

Hence, extra dividends in 2019 are $5,047,000

Thus, an even higher use of excess funds may be a stock repurchase.

b)

Summary Introduction

To discuss: Policies recommended by person X to the company and restrict those to listed ones.

Explanation of Solution

Policy number 4, supported the regular dividend with an extra, appears most reasonable. If this is implemented properly, it would lead to accurate capital budget and accurate financing of that budget, and it might offer correct signals to investors.

c)

Summary Introduction

To discuss: Whether the dividend in 2019 is $9,000,000 is reasonable from the results obtained in part (a) and (b).

Explanation of Solution

A dividend of $9,000,000 in 2019 might be slightly low. It is observed that the capital budget is too substantial, and that more dividends ought to be paid out. Noticeably, it is true to make sure that the organization can be gaining low returns on prevailing assets yet have a great degree productive investment openings this year.

In any case, if the current year’s projects resemble those of historical years, at that point the pay-out seems, by all accounts, to be marginally low.