Question

In 2015, the Keenan Company paid dividends totaling $3,490,000 on net income of $13 million. Note that 2015 was a normal year and that for the past 10 years, earnings have grown at a constant rate of 9%. However, in 2016, earnings are expected to jump to $20.8 million and the firm expects to have profitable investment opportunities of $10.4 million. It is predicted that Keenan will not be able to maintain the 2016 level of earnings growth because the high 2016 earnings level is attributable to an exceptionally profitable new product line introduced that year. After 2016, the company will return to its previous 9% growth rate. Keenan's target capital structure is 40% debt and 60% equity.

1. 
   Calculate Keenan's total dividends for 2016 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.)
   1. Its 2016 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.
      $
   2. 
      
   3. It continues the 2015 dividend payout ratio. Round your answer to the nearest cent. Do not round intermediate calculations.
      $
   4. 
      
   5. It uses a pure residual dividend policy (40% of the $10.4 million investment is financed with debt and 60% with common equity). Round your answer to the nearest cent.
      $
   6. 
      
   7. 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 dividend policy. Round your answer to the nearest cent.
2. 
   
3. Which of the preceding policies would you recommend?
   -Select-Policy 1Policy 2Policy 3Policy 4Item 6
4. 
   
5. Assume that investors expect Keenan to pay total dividends of $8,000,000 in 2016 and to have the dividend grow at 9% after 2016. The stock's total market value is $220 million. What is the company's cost of equity? Round your answer to two decimal places.
   %
6. 
   
7. What is Keenan's long-run average return on equity? [Hint: g = Retention rate x ROE = (1.0 - Payout rate)(ROE).] Do not round intermediate calculations. Round your answer to two decimal places.
   %
8. 
   
9. Does a 2016 dividend of $8,000,000 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 higherItem
   

Answer 1

Given,

Dividends for 2015 = $ 3490000

Net income(earnings) for 2015 = $ 13000000

Growth rate (g) = 9% or 0.09

Net income (2016) = $ 20800000

Investment = $ 10400000

Solution :-

la) ) Total dividends (Rol6) Dividands far 2o1S $3490000 (1+ 0.09) $349 0000(1.09 $3804100 pividend feyout atio (Rols) Dividerd far 2015 Earnings fer Ro1s -0.26846 153846 3490000 13 000000 Now Total Diviclends Ro16) Net Inlome Ro16) x Diviclencl Payout atioRos) O.26846153846 $20800000 X $ S584000 I N

3) Equity financing nvestment Xequity financing ratio -1 $10400000 1 $ 6240000 Now Total Dividends (2o16) Net Intome Ro)6) - Equity Ainancin2 $6340000 20800000 14560000 3804100 Regular Dividencd Residual Pelicy dividlend $ 14560000 Ser Extra dividencl EResiclual folicay Di'vidend Regular Dividend

-43804100 E1456.0000 $10255900 1 en regular clividercl, Policy Based is delommendledl aExpectec otal Dividerd (Rel6) $8000000 Dividerd growth rate la)- 9 or 0.09 Total market Value of stock (P) $330000o00 No4 lompanyls lost of equity Expected total Dluidend Bol6) $8000000 $R200000o0 0. 09 O. 0364 t 0.09 0.1R64 or 12. 64%

Thus lompany s Cost of equity aouled be 12.64% Icl) As Calulateol belart Dividendl Payout Tatio O. 36846153846 Carotn oate l9) 9 O 0.09 Novs 2(Retention ratio) (RoE) 1-Dividend Payout) (ROE Tatio 9 0.09=(1-0.26846153846) (ROE O.09 10.731S38461S4) (ROE 09 0.73153846IS4 Ro E 0.1230 or 12. 307 ROE So, keenan's Long- xun average return on equity is 1R.30