Problem 14-9 Alternative dividend policies In 2013 the Keenan Company paid divid
ID: 2734316 • Letter: P
Question
Problem 14-9
Alternative dividend policies
In 2013 the Keenan Company paid dividends totaling $2,940,000 on net income of $12.5 million. Note that 2013 was a normal year and for the past 10 years, earnings have grown at a constant rate of 5%. However, in 2014, earnings are expected to jump to $17.5 million and the firm expects to have profitable investment opportunities of $9.5 million. It is predicted that Keenan will not be able to maintain the 2014 level of earnings growth because the high 2014 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2014, the company will return to its previous 5% growth rate. Keenan's target capital structure is 40% debt and 60% equity.
Calculate Keenan's total dividends for 2014 assuming that it follows each of the following policies: (Write out your answers completely. For example, 25 million should be entered as 25,000,000.)
Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.
$
It continues the 2013 dividend payout ratio. Round your answer to the nearest cent.
$
It uses a pure residual dividend policy (40% of the $9.5 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent.
$
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. Round your answer to the nearest cent.
Which of the preceding policies would you recommend?
-Select-Policy 1Policy 2Policy 3Policy 4Item 6
Assume that investors expect Keenan to pay total dividends of $6,000,000 in 2014 and to have the dividend grow at 5% after 2014. The stock's total market value is $200 million. What is the company's cost of equity? Round your answer to two decimal places.
%
What is Keenan's long-run average return on equity? [Hint: g = Retention rate x ROE = (1.0 - Payout rate)(ROE).] Round your answer to two decimal places.
%
Does a 2014 dividend of $6,000,000 seem reasonable in view of your answers to parts c and d? If not, should the dividend be higher or lower?
-Select-yesno, it should be lowerno, it should be higher
Explanation / Answer
Earnings in 2014 are $17.5 mn
a. To set dividends to grow at long term growth rate, dividend issued should be 5% more than 2013 dividends
= 2.94 * 1.05 = 3.087 mn = 3,087,000
b. Dividend payout ratio in 2013 = 2.94 / 12.5 = 23.52%
So 2014 Dividends = 17.5 * 23.52% = 4.116 mn = 4,116,000
c. In pure residual dividend policy, first capital investments are made and then remaining earnings are distributed to shareholders as dividends
So Capital investment needed from equity = 60% * 9.5 = 5.7mn
So dividends issued = 17.5 - 5.7 = 11.8 Mn = 11,800,000
d. Regular Dividend = as calculated above = 3.087 Mn
Remaining earnings = 17.5 - 3.087 = 14.413 Mn
Capex from earnings = 60% * 9.5 = 5.7mn
So Extra dividend = 14.413 - 5.7 = 8.713 Mn = 8,713,000