Question

Boehm Corporation has had stable earnings growth of 6% a year for the past 10 years, and in 2019 Boehm paid dividends of $1 million on net income of $10 million. However, net income is expected to grow by 22% in 2020, and Boehm plans to invest $7.5 million in a plant expansion. This one-time unusual earnings growth won't be maintained, though, and after 2020 Boehm will return to its previous 6% earnings growth rate. Its target debt ratio is 34%. Boehm has 1 million shares of stock.

1. Calculate Boehm's dividend per share for 2020 under each of the following policies:
   1. Its 2020 dividend payment is set to force dividends per share to grow at the long-run growth rate in earnings. Round your answer to the nearest cent.

      $  

   2. It continues the 2019 dividend payout ratio. Round your answer to the nearest cent.

      $  

   3. It uses a pure residual policy with all distributions in the form of dividends (34% of the $7.5 million investment is financed with debt). Round your answer to the nearest cent.

      $  

   4. 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. What will the extra dividend be? Round your answer to the nearest cent.

      $  

2. Which of the preceding policies would you recommend?

   -Select-

Answer 1

Answer : Calculation of Dividend per share :

Given

Dividend in 2019 = 1 million

Earnings in 2019 = 10 million

Earnings in 2020 = 10 million * (1 + 0.22) = 12.2 million

(a.) Its 2020 dividend payment is set to force dividends per share to grow at the long-run growth rate in earnings:

Dividend in 2020 = Dividend in 2019 * (1 + growth rate)

= 1 million * (1 + 0.06)

= 1.06 million

Dividend per share = Total Dividend / Number of equity share

= 1.06 million / 1 million

= $1.06

It continues the 2019 dividend payout ratio.

Dividend payout ratio in 2019 = Dividend in 2019 / Earning in 2019

= 1 million / 10 million

= 10%

Total Dividend = Earning in 2020 * Dividend payout ratio in 2019

= 12.2 million * 10%

= 1.22 million

Dividend per share = Total Dividend / Number of equity share

= 1.22 million / 1 million

= $1.22

It uses a pure residual policy with all distributions in the form of dividends (34% of the $7.5 million investment is financed with debt)

Residual Dividend = Earning in 2020 - Investment financed through equity

= 12.2 million - [7.5 * (1 - 0.34)]

= 7.25 million

Dividend per share = Total Dividend / Number of equity share

= 7.25 million / 1 million

= $7.25

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:

Total Dividend = Regular Dividend (calculated in part i) + Extra Dividend

Extra Dividend = Earning in 2020 - Investment financed through equity - Regular Dividend (calculated in part i)

= 12.2 million - [7.5 * (1 - 0.34)] - 1.06 million

= 7.25 million - 1.06 million

= 6.19 million

Total Dividend = Regular Dividend (calculated in part i) + Extra Dividend'

= 6.19 miliion + 1.06 million

= 7.25 million

Dividend per share = Total Dividend / Number of equity share

= 7.25 million / 1 million

= $7.25

(b.) Continue with the regular dividend based on long run growth rate.