Question Details

a low growth firm





1. (8 points) In 2004, the Lissa Company, a low growth firm, paid dividends of $5,000,000 on after-tax income (cash
flow) of $25,000,000. Capital budget projects totaled $4,000,000 in 2004. 2004 was a normal year for earnings,
dividends, and capital budgets. For the past 12 years, earning have grown at a constant rate of 4%. However, in 2005,
earnings are expected to fall to $20,000,000 and the firm expects to have profitable investment opportunities will grow
to 8,000,000. It is predicted that Lissa will not maintain the 2005 level of earnings growth, and the company will return
to the 2004 earnings (25,000,000) and growth rate (4%) in 2006. Lissa's is an all equity firm.
a. Calculate Lissa's total dividends for 2005 if its dividend payment is set to force dividends to grow at the long-run growth rate in earnings.
b. Calculate Lissa's total dividends for 2005 if it continues its 2004 dividend payout ratio.
c. Calculate Lissa's total dividends for 2005 if it uses a pure residual dividend.
d. Choosing only amoung a, b, and c, What is Lissa- optimal dividend policy? Why?
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