91Ó°ÊÓ

Phillips Rock and Mud is trying to determine the maximum amount of cash dividends it can pay this year. Assume its balance sheet is as follow

Assets
Cash	\(386,000
Accounts receivables	\)836,000
Fixed assets	\(1,048,000
Total assets	\)2,270,000
Liabilities
Accounts payable	\(459,000
Long term payable	\)371,000
Common stock (295,000 shares at \(1 par)	\)295,000
Retained earnings	\(1,145,000
	\)2,270,000

a. From a legal perspective, what is the maximum amount of dividends per share the firm could pay?

b. In terms of cash availability, what is the maximum amount of dividends per share the firm could pay?

c. Assume the firm earned an 18 percent return on stockholders’ equity last year. If the board wishes to pay out 50 percent of earnings in the form of dividends, how much will dividends per share be? (Round to two places to the right of the decimal point.)

Step by step solution

01

Calculation of legal limit of paying dividend per share

The firm can pay a maximum total dividend equal to its retained earnings, i.e., $1,145,000. The dividend per share will be $3.88

$\begin{array}{rcl}\text{Dividend per share}& =& \frac{\text{Retained earnings}}{\text{Shares}}\\ & =& \frac{\$1,145,000}{295,000}\\ & =& \$3.88\end{array}$

02

Calculation of maximum amount of dividends payable based on cash availability

The maximum amount of dividend will be $1.30.

$\begin{array}{rcl}\text{Maximum amount of dividend}& =& \frac{\text{Cash balance}}{\text{Shares}}\\ & =& \frac{\$386,000}{295,000}\\ & =& \$1.3\end{array}$

03

Calculation of dividends per share

The dividends per share will be $0.44.

$\begin{array}{rcl}\text{Stockholder's equity}& =& \text{Common stock}+\text{Retained earnings}\\ & =& \$295,000+\$1,145,000\\ & =& \$1,440,000\end{array}$

$\begin{array}{rcl}\text{Net income}& =& \text{Return on equity}×\text{Stockholder's equity}\\ & =& 18\%×\$1,440,000\\ & =& \$259,200\end{array}$

$\begin{array}{rcl}\text{Dividend}& =& \text{Net income}×\text{Pay - out ratio}\\ & =& \$259,200×50\%\\ & =& \$129,600\end{array}$

$\begin{array}{rcl}\text{Dividend pershare}& =& \frac{\text{Dividend}}{\text{Number of shares}}\\ & =& \frac{\$129,600}{295,500}\\ & =& \$0.44\end{array}$

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