Question

Boehm Corporation has had stable earnings growth of 6% a year for the past 10 years, and in 2015 Boehm paid dividends of $4.0 million on net income of $15.5 million. However, in 2016 earnings are expected to jump to $27.9 million, and Boehm plans to invest $12.4 million in a plant expansion. This one-time unusual earnings growth won't be maintained, though, and after 2016 Boehm will return to its previous 6% earnings growth rate. Its target debt ratio is 35%.

a. Calculate Boehm's total dividends for 2016 under each of the following policies:

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 dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.

2. It continues the 2015 dividend payout ratio. Round your answer to the nearest dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.

3. It uses a pure residual policy with all distributions in the form of dividends (35% of the $12.4 million investment is financed with debt). Round your answer to the nearest dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.

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. Round your answer to the nearest dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.

Which of the preceding policies would you recommend? Restrict your choices to the ones listed (1,2,3 or 4)

Answer 1

case 1

long term growth rate = 6% and so dividend will also grow by 6%

so next year dividend = 4 x (1.06) = 4.24 million =

Answer = $ 4,240,000

case 2

Dividend payout ratio in 2015 = (dividend /net income) * 100 = (4/15.5) *100 = 25.806%

So dividend for 2016 will be = 27.9 x 25.806% =7.1999 million =

Answer : $7,199,900

case 3

pure residual policy

earnings in 2016 = 27.9 – (12.4 x 65% in new project) = 27.9 – 8.06 = 19.84 million =

Answer : $19,840,000

case 4

regular dividend policy plus extra policy

regular dividend = 4.24 million as we calculated in case above

extra dividend = 27.9 – (12.4 x 65% in new project) - 4.24 (=dividend as per regular policy) = $ 15.6 million = Answer : $ 15,600,000

as the earnings will come back to normal levels again after a year, dividend should be paid on the basis of long term growth rate that is @6%. that's the best policy

will not disappoint shareholders next year, when earnings will become normal

Go through it, Any doubts, please feel free to ask, Give positive feedback, Thank you