Question

1. (10 points). Z-Tec, a firm providing Internet services, reported net income of $10 million in the most recent year, while making $25 million in capital expenditures (depreciation was $5 million). The firm had no working capital needs and uses no debt. a. (5 points) Can the firm afford to pay out dividends right now? Why or why not? b. (5 points) Assuming net income grows 40 percent a year and that net capital expenditures grow 10 percent a year, when will the firm be in a position to pay dividends?

Answer 1

a) Z-Tech is not in position to pay dividends right now as there is an capital expenditure of $25 million, and this expenditure cannot be covered by debt as firm do not uses debt so it need to be serviced by Owners capital/Reserves and surplus or  Net Income.

b) If Net in come increases by 40% per year and Capital Expenditure by 10%,  we need to make a schedule for expected Net income and Capital Expenditures as follow:

ear 1	1	2	3	4	5	6
Net Income	10	14	19.6	27.44	38.41	53.78
Cap Ex	25	27.5	30.25	33.27	36.60	40.26

In Year 5 Net income started surpassing Cap Ex requirements so remained amount of net income from year 5 can be distributed as dividends.

Calculations:

Net Income : 40% of previous years net income added to obtain Net income for the year

Cap. Ex: 10% of previous years Cap Ex. added to obtain Cap Ex. for the year.