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Paying Dividends versus Budgeting Expenses

Lyone, Inc. is a non-union manufacturer of consumer household goods. Their industry is largely union, yet they have remained without a union because employees have always felt that they could work well with management and that management protected the employees and treated them fairly. Recently, the employees have sought a pay increase after accepting a wage freeze last year. The economy has improved, production is at an all-time high, and employees want to be rewarded for their efforts and loyalty.

The Board of Directors is aware that with the high earnings recently announced, shareholders are expecting high returns after a dismal four quarters last year. If they approve a modest pay increase for the employees who accepted the wage freeze last year, they will not be able to release the high-rate dividends to shareholders. Also, the Board fears that a failure to comply with the reasonable employee demand might prompt the employees to seek union representation, something the Board does not want to encounter.

Solution Preview

With the limited information provided, we should distinguish a couple of things before proceeding to a potential solution. It appears that the Board is possibly confusing a couple of issues. When a firm records "high" earnings, it assumes that the NET PROFIT CALCULATION FROM THE INCOME STATEMENT IS HIGHER THAN FORECAST OR HIGHER THAN ANTICIPATED. This Net Profit is then moved to the Balance Sheet, to the Equity section, labeled under Retained Earnings.

Dividends are paid from the Retained Earnings account, meaning that there are no tax consequences to the firm, but there ate tax issues to the shareholder in the form of Income from investments, namely Dividends received. Essentially this means that the firm has a higher level of cash available to it, so that these dividends can be paid to the shareholder(s).

So the real issue is not the earnings capacity or capability of the firm, but the availability of cash to provide a higher level of return to the shareholders.

With respect to the notion that the employees would expect a wage adjustment based on the fact that wages were frozen and that the firm is now experiencing a high level of output for its products, this would come in the form of revising the NEXT YEAR'S BUDGET TO ACCOMMODATE THIS NEED. For example, the above information does ...

Solution Summary

How to satisfy the need to pay dividends while simultaneously exploring the need to increase expenses in the form of compensation - possible options and solutions.

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