Question

4. Dividend Policy Decisions
Friendly Corp had a banner year with earnings of $ 3 million. Those earnings made their Retained Earnings balance jumped to $ 5 million. The rest of the Balance Sheet is:
Cash $ 250,000
Accounts Payable 350,000
Accounts Receivable 500,000
Goodwill 1,850,000
Property, Plant and Equipment 6,000,000
L/T Debt 1,250,000
Common Stock 2,000,000
Retained Earnings 5,000,000
Required:
a. Should the board declare a $ 1 million cash dividend in 6 months because of its earnings record year?
b. Assuming Friendly Corp pays $ 1 million cash dividend, what would be the earnings retention rate?
Why is this metric important?
c. If the stock price is $ 50 would you buy this stock? Why?

Answer 1

a). I suggest no dividend declare in 6 months, because dividend declare $1 million but cash balance is $2,50,000. If cash received form all accounts receivable then after Cash balance $7,50,000. Cash not sufficient for dividend declaration.

b). Retention ratio = 1 - dividend payout ratio

Retention Ratio = 1 - 20%

= 80%

Dividend payout ratio = (Dividend declared / Total Retained earnings)*100

= ($1 million / $5 million)*100

= 20%

In this case retention ratio is high and retention money invest in company

c). Book value of Share = Stockholders' equity / no. Of common stock

= $70,00,000/200000

= $35 per share

Buy value of share is higher than book value, I suggest can not buy shares