Q7BP A financial analyst is attemptin... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 5: Q7BP (page 596)

A financial analyst is attempting to assess the future dividend policy of Environmental Systems by examining its life cycle. She anticipates no payout of earnings in the form of cash dividends during the development stage (I). During the growth stage (II), she anticipates 12 percent of earnings will be distributed as dividends. As the firm progresses to the expansion stage (III), the payout ratio will go up to 35 percent and will eventually reach 58 percent during the maturity stage (IV).
a Assuming earnings per share will be as follows during each of the four stages, indicate the cash dividend per share (if any) during each stage.
Stage I
$0.10
Stage II
$1.80
Stage III
$2.80
Stage IV
$3.70
b. Assume in Stage IV that an investor owns 325 shares and is in a 15 percent tax bracket. What will be the investor鈥檚 after-tax income from the cash dividend?
c. In what two stages is the firm most likely to utilize stock dividends or stock splits?

Short Answer

Expert verified

The dividend in stage I is 0, stage II is $0.22, stage III is $0.98, and stage IV is $2.15. The after-tax income will be $593.94. The company will utilise stock dividends and split them into stages II and III.

Step by step solution

Calculation of cash dividend

	Earnings	Pay-out ratio	Dividends
Stage I	$0.10	0	0
Stage II	$1.80	12%	$0.22
Stage III	$2.80	35%	$0.98
Stage IV	$3.70	58%	$2.15

Calculation of after-tax income

The after-tax income will be $593.94.

$Dividend = Shares 脳 Dividends per share = 325 脳 $ 2.15 = $ 698.75$

$After - tax income = Dividend 脳 (1 - Tax rate) = $ 698.75 脳 (1 - 0.15) = $ 698.75 脳 0.85 = $ 593.94$

The stages where the company should utilize stock dividends and stock splits

The company is most likely to utilise the stock dividend and split during stages II and III as stage II is the growth stage and stage III is the expansion stage.

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Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders鈥� equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder鈥檚 equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder鈥檚 equity	\)15,680,000
Total liabilities and stockholder鈥檚 equity	$28,650,000

In \( millions	In \) millions
Current assets	\(70	Current liabilities	\)30
Fixed assets	\(70	Long-term liabilities	\)30
		Total liabilities	\(60
		Stockholder鈥檚 equity	\)80
Total assets	\(140	Total stockholder鈥檚 equity and liabilities	\)140

Assets
	Book value	Liquidation value
Accounts receivables	\(1,400,000	\)1,200,000
Inventory	\(1,800,000	\)900,000
Machinery and equipment	\(1,100,000	\)600,000
Building and plant	\(4,200,000	\)2,500,000
Total assets	\(8,500,000	\)5,200,000

Liabilities and stockholder鈥檚 claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder鈥檚 claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder鈥檚 claims	\)900,000
Total liabilities and stockholder鈥檚 claims	$8,500,000

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Short Answer

Step by step solution

Calculation of cash dividend

Calculation of after-tax income

The stages where the company should utilize stock dividends and stock splits

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