Question

Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2015 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2016 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant extension. This one-time unusual earnings growth won’t be maintained, though, and after 2016 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%.

1. 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.

   2. It continues the 2015 dividend payout ratio.

   3. It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million investment is financed with debt).

   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.

2. Which of the preceding policies would you recommend? Restrict your choices to the ones listed, but justify your answer.

3. Does a 2016 dividend of $9 million seem reasonable in view of your answers to parts a and b? If not, should the dividend be higher or lower?

Answer 1