Chapter 18: Dividend Policy and Retained Earnings
18-27
b. If the firm simply uses a payout ratio of 40 percent of net income, how much in total
cash dividends will be paid?
c. If the firm pays a 10 percent stock dividend in years 2 through 5, and also pays a cash
dividend of $2.40 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?
18–22. Solution:
Hastings Sugar Corporation
a. Dividends represent what is left over after profitable capital
expenditures are undertaken.
Year
Net
Income
–
Profitable
Capital
Expenditures
Dividends
1
$10 mil.
$ 7 mil.
$ 3 mil.
2
15 mil.
11 mil.
4 mil.
3
9 mil.
6 mil.
3 mil.
4
12 mil.
7 mil.
5 mil.
5
14 mil.
8 mil.
6 mil.
Total cash dividends
$21 mil.
18–22. (Continued)
b.
Chapter 18: Dividend Policy and Retained Earnings
18-28
Year
×
Payout ratio
Dividends
1
.40
$ 4.0 mil.
2
.40
6.0 mil.
3
.40
3.6 mil.
4
.40
4.8 mil.
5
.40
5.6 mil.
Total cash dividends
$24.0 mil.
c.
Year
Shares
outstanding
×
Dividends
per share
Dividends
1
2,000,000
×
$2.40
$ 4,800,000
2
2,200,000
×
2.40
5,280,000
3
2,420,000
×
2.40
5,808,000
4
2,662,000
×
2.40
6,388,800
5
2,928,200
×
2.40
7,027,680
Total cash dividends
$29,304,480
d.
Year
Net
income
Payout
ratio
Dividends
Shares
Dividends
per share
1
$10 mil.
.30
$3.0 mil.
2,000,000
$1.50
2
15 mil.
.30
4.5 mil.
2,400,000
1.88
3
9 mil.
.30
2.7 mil.
2,880,000
.94
4
12 mil.
.30
3.6 mil.
3,456,000
1.04
5
14 mil.
.30
4.2 mil.
4,147,200
1.01
Chapter 18: Dividend Policy and Retained Earnings
18-29
COMPREHENSIVE PROBLEM
Modern Furniture Company (Dividend payments versus stock repurchases) (LO5) Modern
Furniture Company had finally arrived at the point where it had a sufficient excess cash flow of
$4.8 million to consider paying a dividend. It had 3 million shares of stock outstanding and was
considering paying a cash dividend of $1.60 per share. The firm’s total earnings were $12
million, providing $4.00 in earnings per share. The stock traded in the market at $88.00 per
share.
However, Al Rosen, the chief financial officer, was not sure that paying a cash dividend was the
best route to go. He had recently read a number of articles in The Wall Street Journal about the
advantages of stock repurchases and before he made a recommendation to the CEO and board of
directors, he decided to do a number of calculations.
a. What is the firm’s P/E ratio?
b. If the firm paid the cash dividend, what would be its dividend yield and dividend payout ratio
per share?
c. If a stockholder held 100 shares of stock and received the cash dividend, what would
be the total value of his portfolio (stock plus dividends)?
d. Assume instead of paying the cash dividend, the firm used the $4.8 million of excess funds to
purchase shares at slightly over the current market value of $88 at a price of $89.60. How
many shares could be repurchased? (Round to the nearest share.)
e. What would the new earnings per share be under the stock repurchase alternative? (Round to
three places to the right of the decimal point.)
f. If the P/E ratio stayed the same under the stock repurchase alternative, what would be the
stock value per share? If a stockholder owned 100 shares, what would now be the total value
of his portfolio? (This answer should be approximately the same as the answer to part c.)
CP18-1. Solution:
Modern Furniture Company
a. P/E ratio = Price/EPS
b. Dividend yield = Dividend per share/price
Dividend payout ratio =
Chapter 18: Dividend Policy and Retained Earnings
18-30
CP18-1. (Continued)
c. Portfolio value
d. $4,800,000/$89.60 = 53,371 shares
e. EPS = total earnings/total shares
f. Stock price = P/E × EPS
Portfolio value
WEB EXERCISE
1. Autodesk was referred to as a profitable, rapid-growth company in this chapter.
It is a software and service company. This presumably justifies the firm not paying a
cash dividend.
2. Go to www.finance.yahoo.com and enter ASDK (Autodesk) in the “Get Quotes” box.
Scroll down to the income statement.
3. Compute the following ratios for the most recent full year, and compare them to the
stock analysts’ target numbers for the company.
Target
a. Net income/Total revenue………………………………………..
8%
b. Operating income/Total revenue ……………………………….
12%
c. Cost of services/Total revenue (the lower the better) …….
55%
d. General and administrative expense …………………………..
2%
4. Write a one-paragraph summary about Autodesk’s ability to beat the analysts’ targets in
step 4. Do not automatically assume the firm will be able to beat the target numbers as
Autodesk is in a highly competitive environment. Some years it will beat the target
numbers and other years it will not.
Chapter 18: Dividend Policy and Retained Earnings
18-31
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