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Dividend Smoothing

The Sharpe Co. just paid a dividend of $1.50 per share of stock. Its target payout ratio is 40 percent. The company expects to have an earnings per share of $4.15 one year from now.
a. If the adjustment rate is .3 as defined in the Lintner model,what is the dividend one year from now?
b. If the adjustment rate is .6 instead,what is the dividend one year from now?
c. Which adjustment rate is more conservative? why?

Solution Preview

The Lintner formula for dividend payouts by a mature corporation is:

Change in dividends = Constant + (Partial Adjustment Coefficient*(Target dividend-Current dividend)) + Error factor
Because the target dividend is really the expected net income times the target payout ratio,
Change in dividends = Constant + (Partial Adjustment Coefficient*((Expected net income*Target payout ratio)-Current dividend)) + Error factor
For most intents and purposes, the constant and the error factor are 0. Thus, for our purposes,
Change in dividends = ...

Solution Summary

Based upon a company's last dividend, target payout ratio, and expected earnings per share, this solution illustrates how it determines it dividend a year from now based upon several smoothing factors.

$2.19