Question

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

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.

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

Calculation of practical limit

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

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

Calculation of dividend pay-out ratio

The dividend pay-out ratio is 25%.

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