Week 1 Homework Essay

748 Words Aug 19th, 2012 3 Pages

Problem Based on Chapter 14, Residual Dividends
Middlesex Plastics Manufacturing had 2011 Net Income of $15.0 Million. Its 2012 Net Income is forecast to increase by 8%. The company’s capital structure has been 35% Debt and 65% Equity since 2010, and the company plans to maintain this capital structure in 2012. The company paid $3.0 Million cash dividends in 2011. The company is planning to invest in a major capital project in 2012. The capital budget for this project is $12.0 Million in 2012.
2011 Net Income = $15,000,000
2012 Net Income = increased by 8% = ($15,000,000) + ($15,000,000 * 8%) = $16,200,000
2012 Target Equity Ratio = 65%
2011 Dividend Payout = $3,000,000
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Under the residual dividend policy, the company needs 8.4 million additional capital.

5. What would be the prudent dividend policy for 2012?: Pay dividends at the current dividend growth rate of 8%, or pay the residual dividend amount.

The company should pay dividends at the current growth rate of 8% as they have paid in the past (2010 and 2011); at this rate, they are only paying out 20% of their net income; however, by the residual dividend policy, they would pay out over 50% of their net income. Most companies prefer the small, sustainable, regular cash dividends and supplement with stock repurchases.

Problem 19-3 (Chapter 19) on Warrants
This problem is posted on page 781 of the textbook.

(19–3) What effect does the trend in stock prices (subsequent to issue) have on a firm’s ability to raise funds through (a) convertibles and (b) warrants?
“A warrant is a certificate issued by a company that gives the holder the right to buy a stated number of shares of the company’s stock at a specified price for some specified length of time.” (Brigham, Eugene F. . Financial Management: Theory & Practice, 13th Edition. South Western Educational Publishing, 03/2010. p. 765).
Even though warrants are long-term debt with a lower than normal (current) bond coupon rate, they give the holder the right to purchase the specific stock at the specified price during a specified time period (example: 20 year bond).

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