a. Legal limit: $134 million.
b. Practical limit: $35.75 million.
c. Payout ratio: 162.50%.
Here is my analysis of Planetary Travel Company's financial situation:
a. Legal limit on current dividends:
The legal limit on current dividends is the amount of retained earnings that the company can pay out as dividends without violating its capital maintenance policy. This policy requires that the company maintain a minimum level of capital to protect creditors and investors.
In this case, the legal limit on current dividends is **$134,000,000**. This is calculated as follows:
The legal limit on current dividends = Retained earnings
= Stockholders' equity - Common stock
= $184,000,000 - $50,000,000
= $134,000,000
b. Practical limit based on liquidity:
The practical limit on current dividends is the amount of cash that the company can pay out as dividends without jeopardizing its ability to meet its short-term obligations. This limit is lower than the legal limit because the company needs to keep some cash on hand to cover its operating expenses.
In this case, the practical limit on current dividends is **$35,750,000**. This is calculated as follows:
The practical limit on current dividends = Cash + Earnings
= 0.05 * Total assets + Earnings
= 0.05 * $275,000,000 + $22,000,000
= $13,750,000 + $22,000,000
= $35,750,000
c. Dividend payout ratio:
The dividend payout ratio is the percentage of earnings that a company pays out as dividends. This ratio is a measure of how much of its profits a company is returning to its shareholders.
In this case, the dividend payout ratio would be **162.50%** if the company pays out the amount in part b. This is calculated as follows:
Dividend payout ratio = (Practical limit on current dividends / Earnings) * 100%
=($35,750,000 / $22,000,000) * 100%
= 162.50%
Analysis:
Planetary Travel Company has a legal limit on current dividends of $134,000,000. However, the practical limit based on liquidity is much lower at $35,750,000. This is because the company has a relatively low cash balance.
If the company pays out the full practical limit on current dividends, the dividend payout ratio would be 162.50%. This is a very high payout ratio, and it is not sustainable in the long term. If the company wants to maintain a healthy financial condition, it will need to reduce its dividend payout ratio.