Chapter 5: Q6BP (page 596)

Planetary Travel Co. has $240,000,000 in stockholders’ equity. Eighty million dollars is listed as common stock and the balance is in retained earnings. The firm has $500,000,000 in total assets and 2 percent of this value is in cash. Earnings for the year are $40,000,000 and are included in retained earnings.
a. What is the legal limit on current dividends?
b. What is the practical limit based on liquidity?
c. If the company pays out the amount in part b, what is the dividend payout ratio? (Compute this based on total dollars rather than on a per share basis because the number of shares is not given.)
Payout ratio = Dividends/Earnings

Short Answer

Expert verified

The legal limit on current dividends is equal to retained earnings, which is $160,000,000.The practical limit is $10,000,000 with a pay-out ratio of 25%.

Step by step solution

Information provided in the question

Stockholders’ equity = $240,000,000

Listed common stock = $80,000,000

Total assets = $500,000,000

Cash = 2% of total assets

Earnings = $40,000,000

Calculation of retained earnings

The retained earnings are $160,000,000.

$\begin{array}{rcl} Retained earnings & = & Stockholder's equity - Common stock \\ = & $ 240, 000, 000 - $ 80, 000, 000 \\ = & $ 160, 000, 000 \end{array}$

Calculation of practical limit

The practical limit is equal to the cash available and therefore, the practical limit is $10,000,000.

$\begin{array}{rcl} Cash & = & Total assets \times Cash percentage \\ = & $ 500, 000, 000 \times 2 % \\ = & $ 10, 000, 000 \end{array}$

Calculation of dividend pay-out ratio

The dividend pay-out ratio is 25%.

$\begin{array}{rcl} Dividend pay - out ratio & = & \frac{Dividend}{Earnings} \\ = & \frac{$ 10, 000, 000}{$ 40, 000, 000} \\ = & 25 % \end{array}$

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Assets
	Book value	Liquidation value
Accounts receivables	\(1,400,000	\)1,200,000
Inventory	\(1,800,000	\)900,000
Machinery and equipment	\(1,100,000	\)600,000
Building and plant	\(4,200,000	\)2,500,000
Total assets	\(8,500,000	\)5,200,000

Liabilities and stockholder’s claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder’s claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder’s claims	\)900,000
Total liabilities and stockholder’s claims	$8,500,000

Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder’s equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder’s equity	\)15,680,000
Total liabilities and stockholder’s equity	$28,650,000

Short Answer

Step by step solution

Information provided in the question

Calculation of retained earnings

Calculation of practical limit

Calculation of dividend pay-out ratio

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