Alternative dividend policies In 2011 the Keenan Company paid dividends totaling
ID: 2650554 • Letter: A
Question
Alternative dividend policies
In 2011 the Keenan Company paid dividends totaling $3,190,000 on net income of $20 million. Note that 2011 was a normal year and for the past 10 years, earnings have grown at a constant rate of 6%. However, in 2012, earnings are expected to jump to $36 million and the firm expects to have profitable investment opportunities of $14.6 million. It is predicted that Keenan will not be able to maintain the 2012 level of earnings growth because the high 2012 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2012, the company will return to its previous 6% growth rate. Keenan's target capital structure is 40% debt and 60% equity.
Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.
$
It continues the 2011 dividend payout ratio. Round your answer to the nearest cent.
$
It uses a pure residual dividend policy (40% of the $14.6 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent.
$
Which of the preceding policies would you recommend?
-Select-Policy 1Policy 2Policy 3Policy 4Item 6
Assume that investors expect Keenan to pay total dividends of $6,000,000 in 2012 and to have the dividend grow at 6% after 2012. The stock's total market value is $180 million. What is the company's cost of equity? Round your answer to two decimal places.
%
What is Keenan's long-run average return on equity? [Hint: g = Retention rate x ROE = (1.0 - Payout rate)(ROE).] Round your answer to two decimal places.
%
Does a 2012 dividend of $6,000,000 seem reasonable in view of your answers to parts c and d? If not, should the dividend be higher or lower?
-Select-yesno, it should be lowerno, it should be higherItem 9
Hide FeedbackShow All Feedback
Check My Work Feedback
Post Submission Feedback
Solution
Alternative dividend policies
In 2011 the Keenan Company paid dividends totaling $3,190,000 on net income of $20 million. Note that 2011 was a normal year and for the past 10 years, earnings have grown at a constant rate of 6%. However, in 2012, earnings are expected to jump to $36 million and the firm expects to have profitable investment opportunities of $14.6 million. It is predicted that Keenan will not be able to maintain the 2012 level of earnings growth because the high 2012 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2012, the company will return to its previous 6% growth rate. Keenan's target capital structure is 40% debt and 60% equity.
Calculate Keenan's total dividends for 2012 assuming that it follows each of the following policies: (Write out your answers completely. For example, 25 million should be entered as 25,000,000.)Its 2012 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.
$
It continues the 2011 dividend payout ratio. Round your answer to the nearest cent.
$
It uses a pure residual dividend policy (40% of the $14.6 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent.
$
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. Round your answer to the nearest cent.
Regular-dividend $ Extra dividend $
Which of the preceding policies would you recommend?
-Select-Policy 1Policy 2Policy 3Policy 4Item 6
Assume that investors expect Keenan to pay total dividends of $6,000,000 in 2012 and to have the dividend grow at 6% after 2012. The stock's total market value is $180 million. What is the company's cost of equity? Round your answer to two decimal places.
%
What is Keenan's long-run average return on equity? [Hint: g = Retention rate x ROE = (1.0 - Payout rate)(ROE).] Round your answer to two decimal places.
%
Does a 2012 dividend of $6,000,000 seem reasonable in view of your answers to parts c and d? If not, should the dividend be higher or lower?
-Select-yesno, it should be lowerno, it should be higherItem 9
Explanation / Answer
Answer
Policy -1 : stable dividend policy : dividend payment is set to force dividends to grow at the long-run growth rate even when the earnings is expected to be volatile for some period.
So in this case , when the long term earnings is expected to grow at 6% then dividend is also expected to follow the same trend.
Year - 2012 Dividend = 3,190,000 * 1.06 = $ 3,381,400
Policy -2 : Constant Dividend Payout ratio policy : In this case the dividend payout ratio (dividend as a percentage of earnings) is expected to remain constant.
Dividend payout ratio in 2011 = 3.19 / 20 = 0.1595
Dividend payout in 2012 = 0.1595 * 36,000,000 = $ 5,742,000
Policy - 3 : Residual Dividend policy : dividends are based on earnings less funds the firm retains to finance the equity portion of its captial budget.
60 % of 14.6 = $ 8.76 m is financed from earnings
Dividend in 2012 = 36 - 8.76 = 27.24 m
= $ 27,240,000
Regular dividend = 3,190,000 * 1.06 = $ 3,381,400
Extra dividend = 27,240,000 - 3,381,400 = $23,858,600
Policy -1 of stable dividend is the most recommended as the dividend sets the expectations of the investor for the future years. Only one year volatility in earnings ( high or low ) must not impact the stability policy in dividend.
According to Gordon growth model of valuation :
P = D1 / (r-g)
180 = 6 / (r- 0.06)
r = cost of equity = 1/30 +0.06 = 9.33 %
g = b * ROE where b = retention ratio
ROE = 0.06 / (1- 0.1595) = 0.07138
ROE = 7.14 %
As suggested Stable dividend policy is recommended in this case. So $ 6 m is more than expected from policy. and must be lower than $6 m.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.