Use the following information for Questions 1 and 2:

Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This one-time unusual earnings growth won?t be maintained, though, and after 2014 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%.

Calculate Boehm?s total dividends for 2014 under each of the following policies:

1. (a) Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings.

(b) It continues the 2013 dividend payout ratio.

2. (a) It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million investment is financed with debt).

(b) 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.

Use the following information for Questions 3 and 4:

Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm?s fixed costs, F, are $2 million, 50 earth stations are produced and sold each year, profits total $500,000, and the firm?s assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carry forwards that render its tax rate zero, its cost of equity is 16%, and it uses no debt.

3. What is the incremental profit? To get a rough idea of the project?s profitability, what is the project?s expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment? Why or why not?

4. Would the firm?s break-even point increase or decrease if it made the change?

Directions: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. This homework assignment is worth 100 points. Use the following information for Questions 1 and 2: Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This one-time unusual earnings growth won't be maintained, though, and after 2014 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%. Calculate Boehm's total dividends for 2014 under each of the following policies: 1. (a) Its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. (b) It continues the 2013 dividend payout ratio. 2. (a) It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million investment is financed with debt). (b) 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. Use the following information for Questions 3 and 4: Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm's fixed costs, F, are $2 million, 50 earth stations are produced and sold each year, profits total $500,000, and the firm's assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carry forwards that render its tax rate zero, its cost of equity is 16%, and it uses no debt. 3. What is the incremental profit? To get a rough idea of the project's profitability, what is the project's expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment? Why or why not? 4. Would the firm's break-even point increase or decrease if it made the change? 1 Dividends, Capital Structures Decisions DIVIDENDS, CAPITAL STRUCTURES DECISIONS 2 Use the following information for Questions 1 through 3: Boehm Corporation has had stable earnings growth of 8% a year for the past 10 years and in 2013 Boehm paid dividends of $2.6 million on net income of $9.8 million. However, in 2014 earnings are expected to jump to $12.6 million, and Boehm plans to invest $7.3 million in a plant expansion. This one- time unusual earnings growth won't be maintained, though, and after 2014 Boehm will return to its previous 8% earnings growth rate. Its target debt ratio is 35%. Calculate Boehm's total dividends for 2014 under each of the following policies: Growth rate Net Income Dividend Dividend/Net Income Ratio Dividend/Net Income % 8% 2013 $9.8 $2.6 0.265306 26.5306% 2014 $10.584 $2.808 2014 $12.600 $3.34 QUESTION #1: Calculate Boehm's total dividends for 2014 if its 2014 dividend payment is set to force dividends to grow at the long-run growth rate in earnings. Step 1: Find the dividend / net income ratio for 2013 Dividend/ Net Income Ratio = Dividend 2013 / Net Income2013 = $2.6 million / $9.8 million = 0.265306 Dividend/Net Income Ratio = 26.5306 % **The dividendet income ratio will be used as the rate for the projection of dividends Step 2: Calculate the 2014 projected net income using the long-run growth rate for Boehm, which is at 8%. Net Income Projected 2014 @ 8% = Net Income 2013 + (Net Income2013) (Growth Rate) = $9.8 million + ($9.8 million) (0.08) Net Income Net Income Projected 2014 @ 8% = $10.584 million Step 3: Compute for the total dividend when earnings for 2014 is calculated using the 8% growth rate. Dividend Total = (Net Income Net Income Projected 2014 @ 8%) (Dividend/Net Income Ratio) = ($10.584 million) (26.5306 %) = ($10.584 million) (0.265306) Total Dividend Projected Income 2014 @ 8%) = $2.808 million or $2,808,000 Answer: Boehm's total dividend for 2014 when earnings are set to grow at its long-run growth rate is $2.808 million or $2,808,000 QUESTION # 2: Calculate Boehm's total dividends for 2014 if it continues the 2013 dividend payout ratio. The net income that is used is this case is the 2014 earnings with an expected jump to $12.6 million. Solution: Dividend Total 2014 = (Net Income 2014) (Dividend/Income Ratio) = ($12.6 million) (26.5306 %) = ($12.6 million) (0.265306) Dividend Total 2014 = $3.34 million Answer: Boehm's total dividend for 2014 if it continues the 2013 dividend payout ratio Is $3.34 million. QUESTION # 3: It uses a pure residual policy with all distributions in the form of dividends (35% of the $7.3 million investment is financed with debt). Using the residual distribution policy: Method 1: Capital budget = $7.3 million 35% of the capital budget = 35% ($7.3 million) = $2.555 Total Dividend2014 = Net Income2014 - (Capital Budget2014 - $2.555million) = $12.6 million - ($7.3 million - $2.555 million) = $12.6 million - $4.745 million Total Dividend for 2014 = $7.855 million Method 2: For a target debt ratio of 35% Target equity ratio = 100% - 35% = 65% Total dividend 2014 = Net Income - (Target equity ratio) (Total capital budget) = $12.6 million - (0.65) ($7.3 million) = $12.6 million - $4.745million Total dividend 2014 = $7.855 million Answer: Boehm's total dividend for 2014 when using a pure residual policy with all distributions with 35% of target debt ratio of the capital budget is $7.855 million QUESTION # 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. a. Regular dividend based on the long-run growth rate: Growth rate Net Income Dividend Dividend/Net Income Ratio Dividend/Net Income % 8% 2013 $9.8 $2.6 0.265306 26.5306% 2014 $10.584 $2.808 2014 $12.600 $3.34 Total Dividend = (Net Income2014) (Dividend Payout Ratio) = ($10.584 million) (26.5306%) = $2.808 million or $2,808,000 Total Dividend2014 = $2.808 million or $2,808,000 b. Extra dividend according to the residual policy Target debt ratio = 35% Target equity ratio = 100% - 35% = 65% Extra dividend = Net Income2013 - (Target Equity Ratio) (Total Capital Budget) = $9.8 million - (0.65) ($7.3 million) = $9.8 million - $4.745 = $5.06 million Answer: a) Regular dividend = $2.808 million or $2,808,000 b) Extra dividend according to residual policy = $5.06 million Use the following information for Questions 5 and 6: Schweser Satellites Inc. produces satellite earth stations that sell for $100,000 each. The firm's fixed costs, F, are $2 million, 50 earth stations are produced and sold each year, profits total $500,000, and the firm's assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $4 million to investment and $500,000 to fixed operating costs. This change will (1) reduce variable costs per unit by $10,000 and (2) increase output by 20 units, but (3) the sales price on all units will have to be lowered to $95,000 to permit sales of the additional output. The firm has tax loss carry forwards that render its tax rate zero, its cost of equity is 16%, and it uses no debt. QUESTION # 5: What is the incremental profit? To get a rough idea of the project's profitability, what is the project's expected rate of return for the next year (defined as the incremental profit divided by the investment)? Should the firm make the investment? Why or why not? Schweser Sattelites Inc. Input Data Total assets Book equity Debt Interest rate Sales Price (P) Expected units sold (Q) Fixed Cost (F) Variable cost (V) Income Statements Sales Revenue (P x Q) Fixed Cost (F) VxQ EBIT/ Profit Incremental Profit = $ $ $ $ $ A 5,000,000 5,000,000 0 16% 100,000 50 2,000,000 50,000 $ 5,000,000 2,000,000 2,500,000 $ 500,000 $ 850,000 B (NEW INVESTMENT) $ 9,000,000 $ 9,000,000 0 16% $ 95,000 70 $ 2,500,000 $ 40,000 $ $ 6,650,000 2,500,000 2,800,000 1,350,000 Step 1: Find for the Variable cost per unit Using the basic profit equation: Profit = Sales - Expenses = Sales - (Variable cost + Fixed cost) Profit + Fixed cost = Units Sold (Unit Sales Price - Unit Variable Cost) $500,000 + $2,000,000 = 50 ($100,000) - V(50) V50 = 50($100,000) - 2,000,000 - 500,000 V = 50 ($100,000) - $2,000,000 - $500,000 / 50 V = $50,000 Variable cost per unit = $50,000 Since for the new investment the variable cost is $10,000 less than the first variable cost per unit therefore: Variable cost per unit for new investment = $50,000 - $10,000 = $40,000 Step 2: Calculate for the operating profit or EBIT for new investment Profit = Sales Revenue - Fixed Cost - Variable Cost = (P) (Q) - F - (V) (Q) = ($95,000) ((70) - $2,500,000 - ($40,000) (70) = $6,650,000 - $2,500,000 - $2,800,000 Profit NEW INVESTMENT = $1,350,000 Incremental Profit NEW= Profit for the New Plan - Profit for the First Plan = $1,350,000 - $500,000 Incremental Profit NEW = $850,000 Answer: Incremental Profit for the new investment = $850,000 Step 3: Calculate for the new project's expected rate of return. Expected rate of return NEW = Incremental Profit / Investment = $850,000 / $4,000,000 = 0.2125 Expected rate of return NEW = 21.25% Answer: The expected rate of return for the new investment is 21.25%, which is greater than the cost of equity of 16%. Schweser Sattelites Inc. should go ahead with the investment. QUESTION #6: Would the firm's break-even point increase or decrease if it made the change? Step 1: Calculate for the break-even point for the original project or old project: Q BE OLD = FOLD / POLD - VOLD = $ 2,000,000 / $100,000 - $50,000 Q BE OLD = 40 Step 2: Calculate for the break-even point for the net project: Q BE NEW = F NEW / P NEW - V NEW = $ 2,500,000 / $95,000 - $40,000 = $2,500,000 / $55,000 = 45.45 Answer: Yes the break-even point will increase from 40 to 45.45