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		$19 million			$ 7 million
2		19 million			12 million
3		9 million			6 million
4		14 million			7 million
5		17 million			8 million

The Hastings Corporation has 3 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 20 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 $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 40 percent of net income and the firm will pay a 30 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

Answer (a):

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.

If the marginal principle of retained earnings is applied, net income will be first used for profitable capital expenditure and balance will be paid as dividends:

As such over 5 years dividend paid will be = $38 millions

Answer 9(b)

Total net income over 5 years = $78 million

If the firm simply uses a payout ratio of 20 percent of net income,dividend paid over 5 years = $78 million * 20% = $15.6 million

Total cash dividends that will be paid over 5 years = $15.6 million

Answer c:

Total dividends that will be paid over 5 years = $53,579,520

Answer d:

Dividend per share each year will be:

Workings: