DIVIDEND POLICY

1.BostonTurkeywassoimpressedwithyourgraspofcapitalstructurebasicsthattheyhavecomeback to you for some advice on dividend policy. To save you the trouble of having to refer back to page 1, the latestfinancialstatementsarereproducedonthispage.

Revenues

IncomeStatement

$ 1,000,000

- Expenses

$400,000

- Depreciation

$100,000

EBIT

$500,000

- Interest Expense

$100,000

Taxable Income

$400,000

- Tax

$160,000

Net Income

$240,000

Assets

Liabilities

Property, Plant & Equipment

$ 1,500,000

Accounts Payable

$500,000

Land & Buildings

$ 500,000

Long Term Debt

$ 1,000,000

Current Assets

$ 1,000,000

Equity (100,000shrs)

$ 1,500,000

Total

$ 3,000,000

Total

$ 3,000,000

BostonTurkeyexpectsitsrevenuestogrow10%nextyear,anditsexpensestoremainat40%ofrevenues. Thedepreciationandinterestexpenseswillremainunchangedat$100,000nextyear.Theworkingcapital, asapercentageofrevenue,willremainunchangednextyear.

ThemanagersofBostonTurkeyclaimtohaveseveralprojectsavailabletochoosefromnextyear,where they plan to invest the funds from operations, and suggest that the firm really should not be paying dividends. The projects have the following characteristics--

ProjectEquityInvestmentExpected Annual CFtoEquityBeta

A

$ 100,000

12,500

1.00

B

$ 100,000

14,000

1.50

C

$ 50,000

8,000

1.80

D

$ 50,000

12,000

2.00

The market risk premium is 5.5% and the treasury bond rate is 6.25%. The firm plans to finance 40% of its future net capital expenditures (Cap Ex - Depreciation) and working capital needs with debt.

a.Howmuchcanthecompanyaffordtopayindividendsnextyear?

b.Nowassumethatthefirmactuallypaysout$1.00pershareindividendsnextyear.Thecurrentcash balance of the firm is $150,000. How much will the cash balance of the firm be at the end of next year, after the payment of thedividend?

c.The average investor in Boston Turkey is a wealthy individual, who pays 40% in taxes on ordinary incomeandonly28%oncapitalgains.Howmuchwouldyouexpectthepricetodrop ontheex-dividend day,ifthecompanypaysout$1pershareasdividend?