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Alternative Dividend Policy

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In 2008 the Keenan Company paid dividends $3.6 million on net income of $10.8 million. The year was normal, and for the past 10 years, earnings have grown at a constant rate of 10%. However, in 2009, earnings are expected to jump to $14.4 million, and the firm expects to have profitable investments opportunities of $8.4 million. It is predictable that Keenan will not be able to maintain the 2009 level of earnings growth - the high 2009 earning level is attributable to an exceptionally profitable new product line introduced that year- and the company will return to its previous 10% growth rate. Keenan's target debt ratio is 40%.

a. calculate Keenan's total dividends for 2009 if it follows each of the following policies:

1. Its 2009 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
2. It continues the 2008 dividend payout ratio.
3. It uses a pure residual policy with all distributions in the form of dividends (40% of the $8.4 million investment is financed with debt).
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.

b. Which of the preceding policies would you recommend? Restrict your choices to the ones listed but justify your answer.
c. Does a 2009 dividend of $9 million seem reasonable in view of your answers to a and b? If not, should the dividends be higher or lower?

The answers to questions a are
1 $3,960,000
2 $4,800,000
3 $9,360,000
4 Regular= $3,960,000
Extra= $5,400,000

I need to show the work. Show formulas used.

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Solution Preview


Question A1
3,600,000 x (1 + 10%) = 3,960,000

Question A2
3,600,000 / 10,800,000 x 14,400,000 = 4,800,000

Question A3
14,400,000 - ...

Solution Summary

Alternative dividend policies are examined.