Question

The Hastings Sugar Corporation has the following pattern of net income each year, and associated capital expenditure projects. The firm can earn a higher return on the projects than the stockholders could earn if the funds were paid out in the form of dividends. Year Net Income Profitable Capital Expenditure 1 $18 million $ 7 million 2 16 million 12 million 3 11 million 6 million 4 22 million 7 million 5 20 million 8 million The Hastings Corporation has 2 million shares outstanding (The following questions are separate from each other). a. If the marginal principle of retained earnings is applied, how much in total cash dividends will be paid over the five years? (Enter your answer in millions.) b. If the firm simply uses a payout ratio of 40 percent of net income, how much in total cash dividends will be paid? (Enter your answer in millions and round your answer to 1 decimal place.) c. If the firm pays a 20 percent stock dividend in years 2 through 5, and also pays a cash dividend of $3.40 per share for each of the five years, how much in total dividends will be paid? d. Assume the payout ratio in each year is to be 30 percent of net income and the firm will pay a 20 percent stock dividend in years 2 through 5. How much will dividends per share for each year be? (Assume cash dividend is paid after the stock dividend). (Round your answers to 2 decimal places.)

Answer 1

a). Marginal principle of retained earnings is applied then, amount left over after investing in capex will be paid out as dividend:

Year (n)	Net income (mn)	Capex (mn)	Dividends paid (mn) (Net income - Capex)
1	18	7	11
2	16	12	4
3	11	6	5
4	22	7	15
5	20	8	12
		Total	47

Total dividends paid = 47 million

b). Payout ratio of 40%

Year (n)	Net income (mn)	Payout ratio	Dividends (Net income*Payout ratio)
1	18	40%	7.2
2	16	40%	6.4
3	11	40%	4.4
4	22	40%	8.8
5	20	40%	8
		Total	34.8

Dividends paid out 34.8 million

c). Stock dividend of 20% (from year 2 to year 5) and cash dividend of $3.40/share:

Year (n)	Total shares (a) (Increasing at 20% p.a.)	Dividend/share (a)	Dividends paid (a*b)
1	20,00,000	3.4	68,00,000
2	24,00,000	3.4	81,60,000
3	28,80,000	3.4	97,92,000
4	34,56,000	3.4	1,17,50,400
5	41,47,200	3.4	1,41,00,480
		Total	5,06,02,880

Dividends paid out = $50,602,880 or 50.60 million

d). Stock dividend of 20% p.a. (from year 2 to year 5) and payout ratio of 30%

Year (n)	Net income (mn) (a)	Payout ratio (b)	Dividends (Net income*Payout ratio) (mn) ('c)	Shares (mn) (d) (Increasing at 20% p.a.)	Dividend/share (c/d)
1	18	30%	5.4	2.00	2.70
2	16	30%	4.8	2.40	2.00
3	11	30%	3.3	2.88	1.15
4	22	30%	6.6	3.46	1.91
5	20	30%	6.0	4.15	1.45