Question
You have recently been appointed CEO of Wizard House Ltd., a wholesale distributor of magic supplies. One day your CFO reminds you that next week
You have recently been appointed CEO of Wizard House Ltd., a wholesale distributor of magic supplies. One day your CFO reminds you that next week you will have to make recommendations to the board of directors regarding this years annual dividend. This catches you totally by surprise. Luckily, the CFO was kind enough to provide you with some additional information. He shows you the projected income statement and balance sheet, without the effect of any dividend declaration.
Income Statement:
Sales.............................................................................................................................. 44,000,000
COGS............................................................................................................................. 29,400,000
Gross profit................................................................................................................. 14,600,000
Operating expenses................................................................................................... 6,000,000
Operating income before interest.......................................................................... 8,600,000
Interest expense........................................................................................................ 1,000,000
Income before tax...................................................................................................... 7,600,000
Income tax (30%)....................................................................................................... 2,300,000
Net income.................................................................................................................. 5,300,000
Statement of Financial Position:
Current Assets
Cash.............................................................................................................................. 4,000,000
Accounts receivable.................................................................................................. 5,000,000
Inventory..................................................................................................................... 2,000,000
Other............................................................................................................................ 3,700,000
Total Current Assets.................................................................................................. 14,700,000
Long-term investments............................................................................................. 7,000,000
Property, plant and equipment (net)..................................................................... 17,000,000
Total Assets................................................................................................................. 38,700,000
Current Liabilities
Accounts payable....................................................................................................... 2,000,000
Accrued liabilities....................................................................................................... 3,000,000
Other............................................................................................................................ 4,000,000
Total Current Liabilities............................................................................................. 9,000,000
Non-current liabilities................................................................................................ 16,000,000
Shareholders Equity
Common shares......................................................................................................... 1,000,000
Contributed surplus................................................................................................... 4,900,000
Retained earnings (includes this years net income)........................................... 7,800,000
Total Shareholders Equity........................................................................................ 13,700,000
Total Liabilities and Equity................................................................................................. 38,700,000
Other information:
1) Last year, the net income was $3,500,000, and $3,300,000 cash dividends were paid.
2) Wizard House has two debt agreements that call for the corporation to maintain at least $2,500,000 in retained earnings, as well as maintain a debt-to-total-assets ratio of no more than 70%.
3) There has been no change in the number of shares outstanding during the year.
You start to think about the recommendations you are going to make. It is the end of November, and historically the corporation has declared dividends five days before the end of the year.
Instructions
a) What factors will limit the amount to be distributed as dividends?
b) What are important considerations in your decision? What would you recommend? Provide any journal entry that is related to your decision.
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