In 2006 the Keenan Company paid dividends totaling $3,600,000 on net income

of $10.8 million. 2006 was a normal year, and for the past 10 years, earnings

have grown at a constant rate of 10 percent. However, in 2007, 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 2007 level of earnings growththe high 2007 earnings level is attributable to an exceptionally profitable new product line introduced that yearand

the company will return to its previous 10 percent growth rate. Keenan's target

debt ratio is 40 percent.

a. Calculate Keenan's total dividends for 2007 if it follows each of the following

policies:

(1) Its 2007 dividend payment is set to force dividends to grow at the long-run

growth rate in earnings.

(2) It continues the 2006 dividend payout ratio.

(3) It uses a pure residual policy with all distributions in the form of dividends

(40 percent of the $8.4 million investment is financed with debt).

External Equity Financing

Residual Distribution

Policy

Dividend Payout

Stock Split

Residual Distribution

Policy

Alternative Dividend

Policies

(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. Does a 2007 dividend of $9,000,000 seem reasonable in view of your answers

to parts a and b? If not, should the dividend be higher or lower?