Question

15/3 Boehm Corporation has had stable earnings growth of 6% a year for the past 10 years, and in 2019 Boehm paid dividends of $4 million on net income of $10 million. However, net income is expected to grow by 34% 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 6% earnings growth rate. Its target debt ratio is 36%. Boehm has 1 million shares of stock.

1. Calculate Boehm's dividend per share for 2020 under each of the following policies:
2. 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 (36% 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

Answer :

(a.) Calculation of 2020 dividend payment :

For the purpose of calculating dividend in 2020 we need to calculate dividend payout ratio of 2019

Dividend Payout ratio in 2019 = Dividend in 2019 / Net Income in 2019

= 4million / 10million

= 40 %

Calculation of Dividend in 2020 = Net Income in 2020 after long run growth * Dividend Payout ratio in 2019

= (10 million* 1.06) * 40%

= 10.6 million * 40%

= 4.24 million or 4,240,000

Note Long Run growth rate is 6%.

(b.) Calculation of Dividend if It continues the 2019 dividend payout ratio

Calculation of Dividend in 2020 = Net Income in 2020 after the jump of 34% * Dividend Payout ratio in 2019

= (10 million* 1.34) * 40%

= 13.4 million * 40%

= 5.36 million or 5,360,000

(c.) It uses a pure residual policy with all distributions in the form of dividends (36% of the $7.0 million investment is financed with debt)

Target debt ratio of 36 %

Target equity ratio =100 % - Target Debt Ratio

= 100% - 36%= 64%

Net Income in 2020 = 10 million * 1.34 = 13.4 million

Calculation of Dividend in 2020 = Net Income – [(Target equity ratio) * (Capital budget)]

= $13.4 million – [(0.64) * ($7 million)]

= $13.4 million - $4.48million

= $8.92 million or 8,920,000

(d.) 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. Calculation of Extra Dividend

Calculation of Extra Dividend in 2020 = Net Income in 2019 – [(Target equity ratio) * (Capital budget)]

= $10 million – [(0.64) * ($7 million)]

= $10 million - $4.48million

= $5.52 million or 5,520,000