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Please complete the problem fully and show as much work as possible.Please, I\'m

ID: 2709539 • Letter: P

Question

Please complete the problem fully and show as much work as possible.Please, I'm begging :)

In 2011 the Keenan Company paid dividends totaling $3,410,000 on net income of $18 million. Note that 2011 was a normal year and for the past 10 years, earnings have grown at a constant rate of 7%. However, in 2012, earnings are expected to jump to $32.4 million and the firm expects to have profitable investment opportunities of $13.5 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 7% growth rate. Keenan's target capital structure is 40% debt and 60% equity.

a. 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.)

1. 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. $___________

2. It continues the 2011 dividend payout ratio. Round your answer to the nearest cent. $_____________

3. It uses a pure residual dividend policy (40% of the $13.5 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent. $___________

4. 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 $__________

b. Which of the preceding policies would you recommend?

Policy 1, Policy 2, Policy 3, or Policy 4

c. Assume that investors expect Keenan to pay total dividends of $7,000,000 in 2012 and to have the dividend grow at 7% after 2012. The stock's total market value is $170 million. What is the company's cost of equity? Round your answer to two decimal places.

____________%

d. 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.

__________%

e. Does a 2012 dividend of $7,000,000 seem reasonable in view of your answers to parts c and d? If not, should the dividend be higher or lower?

Yes; No, it should be lower; or no, it should be higher

Explanation / Answer

The dividend payout ratio is 3,410,000/18,000,000 = 0.1894

1. The dividends will grow at 7% rate in 2012 as well. hence the dividend is 2012 will 3,410,000*1.07 = $3,648,700

2. If firm continues 2011 policy: In this case the payout ratio for 2011 is 3,410,000/18,000,000 = 0.1894

Hence the dividend in 2012 will be 32,400,000*0.1895 = $6,136,560

3. In residual dividedn payout, the total capital requirement is 13,500,000 . Out of this 60% is equity which is 8,100,000. Hence the residual amount for dividends is 32,400,000 - 8,100,000 = $24,300,000

4. Normal dividend at long term growth rate is $3,648,700. Additonal divided due to residula model is $24,300,000

b.I would recommend Option 1, Since the compnay can pay the dividend at the long term growth rate and keep the additonal profits for future growth opportunities since this is only a one time profit.

c.Cost of equity will be 7,000,000/170,000,000 + 0.07 = 0.1112 =11.12%

d.Long term growth rate g = ROE *(1- payout rate) = 0.1112*(1-0.1894) = 0.0901 = 9.01%

e.No. It should be lower since the long term growth rate is 7% ad 9%. Hence dividend should be lower then 7,000,000

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