Question

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 follows:

Assets Cash $ 406,000
Accounts receivable 832,000
Fixed assets 1,014,000
Total assets $ 2,252,000
Liabilities and Stockholders' Equity
Accounts payable $ 473,000
Long term payable 368,000
Common stock (300,000 shares at $2 par) 600,000
Retained earnings 811,000
Total liabilities and stockholders' equity $ 2,252,000
a-1. From a legal perspective, what is the maximum amount of dividends per share the firm could pay? (Do not round intermediate calculations and round your answer to 2 decimal places.)
a-2. Is this realistic?
A. Yes
B. No
b. In terms of cash availability, what is the maximum amount of dividends per share the firm could pay? (Do not round intermediate calculations and round your answer to 2 decimal places.)
c. Assume the firm earned an 20 percent return on stockholders’ equity last year. If the board wishes to pay out 40 percent of earnings in the form of dividends, how much will dividends per share be? (Do not round intermediate calculations and round your answer to 2 decimal places.)

Answer 1

a-1. From a legal perspective, what is the maximum amount of dividends per share the firm could pay?

Dividends can only be paid from retained earnings because a corporation can distribute dividends only if it has made a profit.

Maximum amount of dividends per share = $811,000 / 300,000 common shares = $2.7033 per share

a-2. Is this realistic?

B. No

No corporation has a 100% dividend payout rate because it uses retained earnings to finance existing or new projects.

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

$1.35 per share because the firm has $406,000 in cash and it has 300,000 outstanding shares.

c. Assume the firm earned an 20 percent return on stockholders’ equity last year. If the board wishes to pay out 40 percent of earnings in the form of dividends, how much will dividends per share be?

ROE = net income / stockholders' equity

20% = net income / $1,411,000

net income = $1,411,000 x 20% = $282,200

dividends = $282,200 x 40% = $112,880

dividends per share = $112,880 / 300,000 = $0.38 per share