Question

A financial analyst is attempting to assess the future dividend policy of Environmental Systems by examining its life cycle. She anticipates no payout of earnings in the form of cash dividends during the development stage (I). During the growth stage (II), she anticipates 14 percent of earnings will be distributed as dividends. As the firm progresses to the expansion stage (III), the payout ratio will go up to 36 percent and will eventually reach 59 percent during the maturity stage (IV).

a. Assuming earnings per share will be as follows during each of the four stages, indicate the cash dividend per share (if any) during each stage. (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations and round your answers to 2 decimal places.)

Stage I	$	0.30
Stage II		1.70
Stage III		2.90
Stage IV		3.20

b. Assume in Stage IV that an investor owns 280 shares and is in a 15 percent tax bracket. What will be the investor’s aftertax income from the cash dividend? (Do not round intermediate calculations and round your answer to 2 decimal places.)

c. In what two stages is the firm most likely to utilize stock dividends or stock splits? (Select two answers. Single click the box with the question mark to produce a check mark for a correct answer and double click the box with the question mark to empty the box for a wrong answer.)

• Stage I
• Stage II
• Stage III
• Stage IV

Answer 1

Requirement (a):

Stage	EPS	Pay out Ratio	Cash Dividend per share
I	$      0.30	0%	$                                   -
II	$      1.70	14%	$                             0.238
III	$      2.90	36%	$                             1.044
IV	$      3.20	59%	$                             1.888

Requirement (b):

After tax income from cash dividend = (Number of shares * Cash Dividend per share) * (1 - tax rate)

= (280 shares * $1.888) * (1 - 0.15)

= $528.64 * 0.85

= $449.344

Requirement (c):

Stage II and Stage III

Explanation:

In the growth stage of product development life cycle, the firm is required to retain its profits for growth and development and the firm can do so by reducing the cash dividends and opting for stock dividends. However, when the product reaches its expansion stage, its cash dividends will increase and the firm needs to keep the price to a level feasible for investors and therefore, will use stock split to keep the price of the stock withing the reach of potential investors.