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Chapter 5: Q6BP (page 596)

Planetary Travel Co. has \(240,000,000 in stockholders鈥� equity. Eighty million dollars is listed as common stock and the balance is in retained earnings. The firm has \)500,000,000 in total assets and 2 percent of this value is in cash. Earnings for the year are $40,000,000 and are included in retained earnings.

a. What is the legal limit on current dividends?

b. What is the practical limit based on liquidity?

c. If the company pays out the amount in part b, what is the dividend payout ratio? (Compute this based on total dollars rather than on a per share basis because the number of shares is not given.)

Payout ratio = Dividends/Earnings

Short Answer

Expert verified

The legal limit on current dividends is equal to retained earnings, which is $160,000,000.The practical limit is $10,000,000 with a pay-out ratio of 25%.

Step by step solution

01

Information provided in the question

Stockholders鈥� equity = $240,000,000

Listed common stock = $80,000,000

Total assets = $500,000,000

Cash = 2% of total assets

Earnings = $40,000,000

02

Calculation of retained earnings

The retained earnings are $160,000,000.

Retained earnings=Stockholder's equity-Common stock=$240,000,000-$80,000,000=$160,000,000

03

Calculation of practical limit

The practical limit is equal to the cash available and therefore, the practical limit is $10,000,000.

Cash=Total assets脳Cash percentage=$500,000,000脳2%=$10,000,000

04

Calculation of dividend pay-out ratio

The dividend pay-out ratio is 25%.

Dividend pay - out ratio=DividendEarnings=$10,000,000$40,000,000=25%

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Most popular questions from this chapter

Tyson Iron Works is about to go public. It currently has after-tax earnings of \(4,400,000, and 4,200,000 shares are owned by the present stockholders. The new public issue will represent 500,000 new shares. The new shares will be priced to the public at \)25 per share with a 3 percent spread on the offering price. There will also be $280,000 in out-of-pocket costs to the corporation.

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Question: Barton Simpson, the chief financial officer of Broadband Inc. could hardly believe the change in interest rates that had taken place over the last few months. The interest rate on A2 rated bonds was now 6 percent. The $30 million, 15-year bond issue that his firm has outstanding was initially issued at 9 percent five years ago. Because interest rates had gone down so much, he was considering refunding the bond issue. The old issue had a call premium of 8 percent. The underwriting cost on the old issue had been 3 percent of par, and on the new issue it would be 5 percent of par. The tax rate would be 30 percent and a 4 percent discount rate would be applied for the refunding decision. The new bond would have a 10-year life. Before Barton used the 8 percent call provision to reacquire the old bonds, he wanted to make sure he could not buy them back cheaper in the open market.

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