14-9 ALTERNATIVE DIVIDEND POLICIES In 2008, Keenan Company paid dividends totaling

$3,600,000 on net income of $10.8 million. Note that 2008 was a normal year and that for the past 10 years, earnings have grown at a constant rate of 10%. 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 Keenan will not be able to maintain the 2009 level of earnings growththe high 2009 earnings level is attributable to an exceptionally profitable new product line introduced that yearand the company will return to its previous 10% growth rate. Keenans target capital structure is 40% debt and 60% equity.

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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 Keenan to pay total dividends of $9,000,000 in 2009 and to have the dividend grow at 10% after 2009. The stocks total market value is $180 million. What is the companys cost of equity?

d. What is Keenans long-run average return on equity? [Hint: g = Retention rate X

ROE = (1.0 - Payout rate)(ROE).]

e. Does a 2009 dividend of $9,000,000 seem reasonable in view of your answers to Parts c and d? If not, should the dividend be higher or lower? Explain your answer.