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You are considering purchasing some Stanley Ltd
You are considering purchasing some Stanley Ltd. common shares. Although Stanley recently had to incur significant expenditures for new capital assets, the company has been relatively profitable over the years and its future prospects look good. The summarized statement of financial position at the end of 2016 is as follows:
|
Cash |
$ 137,500 |
|
Other current assets |
640,500 |
|
Capital assets (net) |
4,702,000 |
|
Total |
$5,480,000 |
|
Current liabilities |
$ 414,000 |
|
Long-term debt |
2,000,000 |
|
Share capital, common shares |
1,000,000 |
|
Retained earnings |
2,066,000 |
|
Total |
$5,480,000 |
The company has 150,000 common shares outstanding, and its earnings per share have increased by at least 10% in each of the last 10 years. In several recent years, earnings per share increased by more than 14%. Given the company's earnings and the amount of retained earnings, you judge that it could easily pay cash dividends of $3 or $4 per share, without reducing its retained earnings. Required: Do you think it is likely you would receive a cash dividend from Stanley during the next year if you were to purchase its shares. Why?
Expert Solution
Answer :-
If you were to purchase its shares, your prospects of receiving a dividend are slight, because although earnings per share has been increasing more than 14% in recent years, the expenditures in capital assets indicate that the company is growing, and is likely to reinvest the assets generated from its profitable operations (net income). Your reasoning that the company can declare a $3 or $4 dividend without making a dent in retained earnings overlooks the fact that cash is required to pay out the dividend. At the current time, the company can declare a maximum $0.92 dividend before exhausting its current cash balance. In addition, the $137,500 cash on hand is likely required to settle current liabilities as they become due.
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