1) Classic Corporation has had steady earnings growth= 8% a year for past 10 years and in 2013 Classic paid dividends of $2.6 million on net income of $9.8 million. Though, in 2014 earnings are expected to jump to $12.6 million, and Classic plans to invest $7.3 million in the plant expansion. This one-time strange earnings growth will not be kept, although, and after 2014 Classic will return to its preceding 8% earnings growth rate. Its target debt ratio is 35%.
i) Compute Classic’s total dividends for 2014 under each of given policies:
(a) Its 2014 dividend payment is set to force dividends to raise at = long-run growth rate in earnings.
(b) It continues 2013 dividend payout ratio.
(c) It utilizes a pure residual policy with all distributions in form of dividends (35% of the $7.3 million investment is financed with debt).
(d) It uses a regular-dividend-plus-extras policy, with regular dividend being based on long-run growth rate and extra dividend being set according to residual policy.
ii) Which of above policies would you suggest? Restrict your options to = ones listed, but give explanation for your answer.
iii) Does a 2014 dividened of $9 million seem sensible in view of your replies to parts a and b? If not, must the dividend be higher or lower?