Case Scenario:
In 2008 the Keenan Company paid dividends $3.6 million on net income of $10.8 million. The year was normal, and for the past 10 years, earnings have grown at a constant rate of 10%. However, in 2009, earnings are expected to jump to $14.4 million, and the firm expects to have profitable investments opportunities of $8.4 million. It is predictable that Keenan will not be able to maintain the 2009 level of earnings growth - the high 2009 earning level is attributable to an exceptionally profitable new product line introduced that year- and the company will return to its previous 10% growth rate. Keenan's target debt ratio is 40%.
Question 1: Calculate Keenan's total dividends for 2009 if it follows each of the following policies:
a. Its 2009 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
b. It continues the 2008 dividend payout ratio.
c. It uses a pure residual policy with all distributions in the form of dividends (40% of the $8.4 million investment is financed with debt).
d. 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.
Question 2: Which of the preceding policies would you recommend? Restrict your choices to the ones listed but justify your answer.
Question 3: Does a 2009 dividend of $9 million seem reasonable in view of your answers to a and b? If not, should the dividends be higher or lower?