Alternative Dividend Policies In 2009, the Keenan Company paid dividends totaling $.3.6 million on net income of $10.8 million. The year was normal, and for the past 10 years, earnings have grown at a constant rate of 10%. However, in 2010, earnings are expected to jump to $14.4 million, and the firm expects to have profitable investment opportunities of $8.4 million. It is predicted that Keenan will not be able to maintain the 2010 level of earnings growth-the high 2010 projected earnings level is attributable to an exceptionally profitable new product line to be introduction that year- and then the company will return to its previous 10% growth rate. Keenan’s target debt ratio is 40%.
a. Calculate Keenan’s total dividends for 2010 if it follows each of the following policies:
(1) Its 2010 dividend payment is set to force dividends to grow at the long-run growth rate in earning.
(2) It continues the 2009 dividend payout ratio.
(3) It uses a pure residual policy with all distributions in the form of dividends (40% of the $8.4 million investment is financed with debt).
(4) It employs a regular-dividend-plus-extras policy, with the regular dividend being based on the long-run growth rate and the extra dividend being set according to the residual policy.
b. Which of the preceding policies would you recommend? Restrict your choices to the ones listed, but justify your answer.