Part 1: Dividend Policy

A-Star Limited is considering its dividend policy for the upcoming year 20xx+1. A-Star has enjoyed a long period of moderate growth of sales and earnings and has maintained stable dividend growth of 2 per cent per annum. The companys net income after tax for 20xx was $100,000, and dividends totalled $60,000.

A-Stars 20xx balance sheet indicates the following capital structure:

Long-term debt $300,000 Ordinary shares $200,000 Retained earnings $800,000

For 20xx+1 A-Star has $100,000 of profitable investment opportunities planned, and net income after tax is forecasted to be $120,000.

Two alternative dividend policies are being considered for 20xx+1 by the company:

1. Maintain the existing debt/assets ratio and treat dividends as a residual.

2. Maintain the previous years dividend payout ratio and treat the debt/assets ratio as a residual.

The directors believe that an issue of ordinary shares would not be feasible in the foreseeable future as the companys ordinary shares are undervalued by the market.

Required:

1. Calculate the 20xx+1 dividend which would be paid out under each of the two alternative policies described above. Show full workings. [4 marks]

2. Calculate and complete the table below for the dividend payout ratio and the debt/assets ratio for 20xx and 20xx+1 under each of the two alternative policies. Show full workings. Briefly comment on the possible effect of each of the above dividend policies on the price of the ordinary shares. [6 marks]

	Policy 1		Policy 2
	20xx	20xx + 1	20xx	20xx + 1
Payout Ratio
Debt/Asset Ratio

Update: The value of assets is equivalent to OSC + R/E + Debt (200,000+800,000+300,000=1,300,000)