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Corporate Financial Management (ACME)

ACME Corporation consists of 250 grocery stores throughout the Midwest. At the beginning of 2008 its statement of net worth showed the following information: Common Stock ($1 par) $400,000; Capital paid in excess of par $1,400,000 and retained earnings $500,000. During the year, net income equaled $160,000. Management was undecided on what to do with the income. Acme paid an annual dividend of $.35 per share last year and the stock price is currently $14.50. Acme has a 6% growth rate in earnings and dividends, and is in the 40% tax bracket.

a) What return on investment would Acme have to earn in order to justify retaining 2010's earnings? Use the formula: Ke= D1/P0 + g

b) What changes would occur in stockholder's equity if a $.25 cash dividend was paid? If a 5% stock dividend was given and no cash dividend was paid?

c) What would EPS be before and after the stock dividend?

Solution Preview

a.
K_e= D_1/P_0 + g
= D_0*(1+g)/P_0 + g
=0.35*(1+6%)/14.5+6%
=8.56%

b.
Cash dividend only affects retained earnings,
Beginning R/E: 500,000
Net Income : 160,000
Cash Dividend: -100,000 (=0.25*400,000 shares)
Ending R/E: 560,000

Common stock: ...

Solution Summary

Corporate financial management is examined. The return on investments for Acme to justify retaining earnings are determined.

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