Question

Your firm successfully issued new debt last​ year, but the debt carries covenants.​ Specifically, you can only pay dividends out of earnings made after the debt issue and you must maintain a minimum quick​ (acid-test) ratio (Current Assets minus Inventory) / Current Liabilities

of 1.2. Your net income this year was $ 70.5 million. Your cash is $ 9.7 ​million, your receivables are $ 8.2 ​million, and your inventory is $ 5.3 million. You have current liabilities of $ 18.9 million. What is the maximum dividend you could pay​ (in cash and in​ stock) this year and still comply with your​ covenants?

Answer 1

Quick ratio = (Current assets - inventory) / current liabilities
1.2 = (Current assets - $5.3 million) / $18.9 million
$18.9 million * 1.2 = Current assets - $5.3 million
Current assets = $22.68 million + $5.3 million = $27.98 million

Required Cash balance to Maintain Quick ratio of 1.2 = $27.98 MILLION - $5.3 MILLION - $8.2 MILLION
= $14.48 million

Maximum Dividend = Net Income - (Required Cash - Available Cash)
= $70.5 million - ($14.48 million - $9.7 million)
= $70.5 million - $4.78 million
= $65.72 million

Maximum dividend you could pay this year = $65.72 million