Question

Boehm Corporation has had stable earnings growth of 4% a year for the past 10 years, and in 2019 Boehm paid dividends of $5 million on net income of $10 million. However, net income is expected to grow by 24% in 2020, and Boehm plans to invest $7.0 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 4% earnings growth rate. Its target debt ratio is 32%. Boehm has 1 million shares of stock.

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 (32% of the $7.0 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.

Answer 1

Solution a.

Dividend payout ratio for 2019 = $5/$10 million*100= 50%

Income for 2020 at growth rate of 4% = ($10million) + ($10 million*4%)

Income for 2020 = $10 million + $0.40 million = $10.40 Million

Dividend for 2020 = $10.40 Million * 50% = $5.20 Million

Solution b .

Dividend = Net income * payout ratio

Dividend = [$10 Million + ($10 million * 24%)] * 50%

Dividend = $12.4 Million * 50% = $6.2 Million

Solution c -

Total Investment = $7.0 Million

Debt finance = $7.0 Million * 24% = $1.68 Million

Dividend for 2020 = Net Imcome - (Capital investment - Investment via debt financing)

Dividend = $12.4 Million - ($7 Million - $1.68 Million)

Dividend = $12.4 Million - $5.32 Million = $7.08 Million

Solution d

Debt ratio = 24%

Equity ratio = 100% - 24% = 76%

Extra Dividend = Net income - (Equity ratio * Investment)

Extra Dividend = $10 Million - ($7 Million * 76%)

Extra Dividend = $10 Million - $5.32Million = $4.68  Million

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