Explore BrainMass

# Payout ratio and dividends

This content was COPIED from BrainMass.com - View the original, and get the already-completed solution here!

Bowles Sporting, Inc. is prepared to report the following income statement (shown in thousands of dollars) for the year in 2006.

Sales \$15,200
Operating costs included depreciation 11,900
EBIT \$ 3,300
Interest 300
EBT \$ 3,000
Taxes (40 percent) \$ 1,200
Net Income \$ 1,800

Prior to reporting this income statement, the company wants to determine its annual dividend. The company has 500,000 shares of stocks outstanding and its stock trades at \$48 per share.

a. The company had a 40 percent dividend payout ratio in 2005. If Bowles wants to maintain this payout ratio in 2006, what will be its per-share dividend in 2006?
b. If the company maintains this 40 percent payout ratio, what will be the current dividend yield on the company's stock?
c. The company reported net income of \$1.5 million in 2005. Assume that the number of shares outstanding has remained constant. What was the company's per share dividend in 2005?
d. As an alternative to maintaining the same dividend payout ratio, Bowles is considering maintaining the same per share dividend in 2006 that it paid in 2005. If it chooses this policy, what will be the company's dividend payout ratio in 2006?
e. Assume this expansion is interested in dramatically expanding its operations and that this expansion will require significant amounts of capital. The company would like to avoid transactions costs involved in issuing new equity. Given this scenario, would it make more sense for the company to maintain a constant dividend payout ratio or to maintain the same per share dividend?

1. I know the answer to A. and B. The answer for A is: Dividend per Share = \$1.44. The answer for B. is: Dividend Yield = 3%. However, I am not sure how the instructor arrived at these answers. Sorry! Please show me how.
2. For Part C, I went online and found the following quote for doing this type of problem. Domash (n.d.) writes:

The dividend yield for a stock is the return you would achieve over the next 12-months, assuming that both the dividend payout and the share price remain constant for the year.
It's calculated by dividing the expected next 12-months dividends by the share price. For example the yield would be 5% for a stock currently trading at \$100 per share that is expected to pay \$5 in dividends over the next year (\$5 divided by \$100). So, the dividend yield to new buyers goes up when share prices drop.
If I understand this correctly, I would take the figure from net income at \$ 1800 and divide that by the \$48 per share price. I came up with this result: \$37.50. Would this be correct? Please, let me know.

3. For this answer, I again went online. Investopedia gives the following information: The percentage of earnings paid to shareholders in dividends.

Calculated as:

I think I will choose the first formula. The yearly dividends per share were \$1.44 and the earnings per share was \$48. The answer for this would be 0.03 or 3 percent. Is this correct? (This would be Part D.).

4. For Part E, I am not sure how to handle this one and I do not know where to go online to accomplish this task. Any assistance you can provide would greatly be appreciated.

#### Solution Preview

a. The company had a 40 percent dividend payout ratio in 2005. If Bowles wants to maintain this payout ratio in 2006, what will be its per-share dividend in 2006?

The total dividend paid would be 1,800X0.4=720 (it is given that 40% of earnings are paid as dividend which is the dividend payout ratio). The number of shares are 500,000. The dividend per share would be 720,000/500,000=\$1.44

b. If the company maintains this 40 percent payout ratio, what will be the current dividend yield on the company's stock?

Dividend Yield = Dividend per ...

#### Solution Summary

The solution explains how to calculate the dividends under different payout ratios

\$2.19