Question

Alternative Dividend Policies

Boehm Corporation has had stable earnings growth of 6% a year for the past 10 years, and in 2015 Boehm paid dividends of $2.8 million on net income of $10.0 million. However, in 2016 earnings are expected to jump to $18 million, and Boehm plans to invest $7.7 million in a plant expansion. This one-time unusual earnings growth won't be maintained, though, and after 2016 Boehm will return to its previous 6% earnings growth rate. Its target debt ratio is 35%.

Calculate Boehm's total dividends for 2016 under each of the following policies:

Its 2016 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Round your answer to the nearest dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.
$   

It continues the 2015 dividend payout ratio. Round your answer to the nearest dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.
$   

It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.7 million investment is financed with debt). Round your answer to the nearest dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.
$   

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. Round your answer to the nearest dollar. Enter your answers in dollars. For example: $2.9 million should be entered as $2,900,000.
$  

Which of the preceding policies would you recommend? Restrict your choices to the ones listed.
-Select-1234Item 5

Answer 1

	2015	2016
Div	2.8
NI	10	18
Payout ratio	28.00%

At long run earnings rate dividend = 2.8*1.06=$2.968 million or $2,968,000

At 2015 payout ratio: 18*.28 million = $5,040,000

	(millions)
Debt financing	2.695
Equity financing	5.005
Net income	18
Dividends	12.995

=$12,995,000

Regular dividend plus extra as per policy = $12,995,000

The best recommended is Regular dividend plus extras policy as it provides stable dividends over time and some extra dividend. The dividend does not decrease when earnings are less.