In 2008 the Sirmans Company paid dividends totaling $3.6 million on net income of $10.8 million. Sirmans had a normal year in 2008, and for the past 10 years, earnings have grown at a constant rate of 10 percent. However, in 2009 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 Sirmans will not be able to maintain the 2009 level of earnings growth—the high 2009 earnings level is attributable to an exceptionally profitable new product line introduced that year—and the company will return to its previous 10 percent growth rate. Sirmans’s target debt ratio is 40 percent.

a. Calculate Sirmans’s total dividends for 2009 if it follows each of the following policies:
(1) Its 2009 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
(2) It continues the 2008 dividend payout ratio.
(3) It uses a pure residual dividend policy (40 percent 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.
c. Assume that investors expect Sirmans to pay total dividends of $9 million in 2009 and to have the dividend grow at 10 percent after 2009. The total market value of the stock is $180 million. What is the company’s cost of equity?
d. What is Sirmans’s long-run average return on equity?
e. Does a 2009 dividend of $9 million seem reasonable in view of your answers to parts c and d? If not, should the dividend be higher or lower?