Question

Adams Corporation manufactures fasteners. The company’s income statements for three years are indicated in Exhibit 1. The balance Sheets for the same period are shown in Exhibit 2.

Exhibit 1

ADAMS CORPORATION
Income Statement
	2015	2016	2017
Sales (all on credit)…………………………	$1,500,000	$1,800,000	$2,160,000
Cost of goods sold………………………	950,000	1,120,000	1,300,000
Gross profit…………………………………	550,000	680,000	860,000
Selling and administrative expense………	380,000	490,000	590,000
Operating profit……………………………	170,000	190,000	270,000
Interest expense…………………….....	30,000	40,000	85,000
Net income before taxes…………………	140,000	150,000	185,000
Taxes…………………………………………	46,120	48,720	64,850
Net Income……………………………..	$93,880	$101,280	$120,150
Shares………………………………………	40,000	40,000	46,000

Adams Corporation has made the following projections 2018. All sales are on credit.

April	$24,000	July	$28,000
May	16,000	August	35,000
June	18,000	September	38,000

Sales in February and March were $36,000 and $28,000, respectively. Experience has shown that of total sales, 5 percent of the sales are not collectible, 35 percent are collected in the month of sale, 50 percent are collected in the following month, and 10 percent are collected two months after sale. Total annual sales for the year 2020 are forecasted to be $2,500,000.

Monthly material purchases are set equal to 20 percent of forecasted sales for the next month. Of the total material costs, 40 percent are paid in the month of purchase and 60 percent in the following month. Labour costs will run $6,000 per month, and fixed overheads is $3,000 per month. Interest payments on the debt will be $4,500 for both March and June. A cash dividend of $20,000 is scheduled to be paid in September. Tax payments of $3,500 are due in June and September.

Exhibit 2

ADAMS CORPORATION
Balance Sheet
Assets	2015	2016	2017
Cash………………………………………………	$20,000	$30,000	$20,000
Marketable securities…………………………	30,000	35,000	50,000
Accounts receivable………………………………	150,000	230,000	330,000
Inventory……………………………………	250,000	285,000	325,000
Total Current Assets………………………………	450,000	580,000	725,000
Net Plant and equipment……………………………	550,000	720,000	1,169,000
Total Assets………………………………………..	$1,000,000	$1,300,000	$1,894,000
Liabilities & Equity
Accounts payable…………………………….	$100,000	$225,000	$200,000
Notes payable (bank)………………………………	100,000	100,000	300,000
Total Current liabilities……………………………	200,000	325,000	500,000
Long-term liabilities……………………………	250,000	331,120	550,740
Total liabilities………………………………………	450,000	656,120	1,050,740
Common stock ($10 par)……………………	400,000	400,000	460,000
Capital paid in excess of par……………….	50,000	50,000	80,000
Retained earnings…………………………………	100,000	193,880	303,260
Total stockholders’ equity……………………………..	550,000	643,880	843,260
Total liabilities and stockholders’ equity………………	$1,000,000	$1,300,000	$1,894,000

Adams Corporation is evaluating three possible investment alternatives for 2018, and their probabilities of occurrence are given below in Exhibit 3:

Exhibit 3: Adams Corporation investment choices

	Alternative 1		Alternative 2		Alternative 3
	Outcomes	Probability	Outcomes	Probability	Outcomes	Probability
Failure	$50	20%	$90	30%	$80	40%
Acceptable	80	40%	160	50%	200	50%
Successful	120	40%	200	20%	400	10%

(a) If adams corporation maintained a dividend payout ratio of 30 percent, how would you describe the corporations dividend policy? ( 3 marks)

Answer 1

Dividend Policy

A Dividend Policy is a method used by a company to structure its dividend payments to its shareholders.

Types of Dividend Policy

1. Stable Dividend Policy
2. Constant Dividend Policy
3. Residual Dividend Policy

Stable Dividend Policy is the most commonly used method. The dividends are steady and predictable every year. Whether the earnings increase or decrease, the dividends remain stable. This approach gives the shareholder more certainty concerning the amount and timing of the dividend.

Under the constant dividend policy, a company pays a percentage of its earnings as dividends every year. Hence in this method, the dividends paid are volatile and are difficult to predict.

With a residual dividend policy, the company pays out dividends that remain after the company has paid for its capital expenditures (CAPEX) and working capital. Dividends are also volatile in this case.

Adams corporation maintaining a 30% payout ratio is following the Constant dividend policy. It will pay 30% of its earning every year and hence the dividends will be volatile and difficult to predict.