Retained Earnings and Dividends You recently have been considering investing in some of Costigan Company’s common stock. The company has been pretty profitable over the years, and prospects for the future look good. However, the company recently has had to make heavy expenditures for new plant and equipment. The company’s summarized balance sheet at the end of 2001 is as follows:

The company has 200,000 shares of stock outstanding, and its earnings per share has increased by at least 10 percent in each of the last 10 years. In several recent years, earnings per share increased by more than 15 percent. Given the company’s earnings and the amount of its retained earnings, you judge that it could easily pay cash dividends of $2 or $3 per share and hardly make a dent in retained earnings.

a. Evaluate the prospects of your receiving a cash dividend from Costigan during the next year if you were to purchase its stock.

b. Evaluate your prospects for receiving cash dividends from Costigan during the next 5 years if you were to purchase its stock.

c. Suppose Costigan borrowed cash of $2 million on a 5-
year bank loan to provide working capital and additional operating flexibility. While no collateral would be required, the loan would stipulate that no dividends be paid in any year in which the ratio of long-term debt to equity was greater than 2 to 3. Evaluate your prospects for receiving cash dividends from Costigan in the short term and during the next 5 years if Costigan were to enter into the bank loan agreement.

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Cash Other current assets Plant & equipment (net) Total Current liabilities $ 50,000 943,000 8,279,000 $9,272,000 $ 588,000 Long-term debt 2,500,000 Common stock 4,000,000 Retained earnings 2,184,000 Total $9,272,000