Dividend distribution You have recently been appointed CEO of Dumbledore Ltd., a wholesale distributor of magic supplies....

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Finance

Dividend distribution
You have recently been appointed CEO of Dumbledore Ltd., awholesale distributor of magic supplies. One day your CFO remindsyou that next week you will have to make recommendations to theboard of directors regarding this year’s annual dividend. Thiscatches you totally by surprise. Luckily, the CFO was kind enoughto provide you with some additional information. He shows you theprojected income statement and balance sheet, without the effect ofany dividend declaration.
Income Statement:
Sales..............................................44,000,000
COGS.............................................29,400,000
Grossprofit.........................................14,600,000
Operatingexpenses..................................6,000,000
Operating income beforeinterest.......................8,600,000
Interestexpense.....................................1,000,000
Income beforetax...................................7,600,000
Income tax(30%)....................................2,300,000
Net income.........................................5,300,000
Statement of Financial Position:
Current Assets
Cash..............................................4,000,000
Accountsreceivable..................................5,000,000
Inventory...........................................2,000,000
Other..............................................3,700,000
Total CurrentAssets.................................14,700,000
Long-term investments................................7,000,000
Property, plant and equipment(net).....................17,000,000
TotalAssets........................................38,700,000
Current Liabilities
Accountspayable....................................2,000,000
Accruedliabilities....................................3,000,000
Other..............................................4,000,000
Total CurrentLiabilities...............................9,000,000
Non-currentliabilities.................................16,000,000
Shareholders’ Equity
Common shares.....................................1,000,000
Contributedsurplus..................................4,900,000
Retained earnings (includes this year’s netincome).........7,800,000
Total Shareholders’Equity.............................13,700,000
Total Liabilities andEquity................................38,700,000
Other information:
1)Last year, the net income was $3,500,000, and $3,300,000 cashdividends were paid.
2)Dumbledore has two debt agreements that call for thecorporation to maintain at least $2,500,000 in retained earnings,as well as maintain a debt-to-total-assets ratio of no more than70%.
3)There has been no change in the number of shares outstandingduring the year.
You start to think about the recommendations you are going tomake. It is the end of November, and historically the corporationhas declared dividends five days before the end of the year.
Instructions
a)What factors will limit the amount to be distributed asdividends?
b)What are important considerations in your decision? What wouldyou recommend?Provide any journal entry that is related to yourdecision.

Answer & Explanation Solved by verified expert

3.9 Ratings (580 Votes)

aWhat factors will limit the amount to be distributed as dividends Ans The two debt agreements that call for the corporation to maintain at least 2500000 in retained earnings as it will restrict the See Answer

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Dividend distributionYou have recently been appointed CEO of Dumbledore Ltd., awholesale distributor of magic supplies. One day your CFO remindsyou that next week you will have to make recommendations to theboard of directors regarding this year’s annual dividend. Thiscatches you totally by surprise. Luckily, the CFO was kind enoughto provide you with some additional information. He shows you theprojected income statement and balance sheet, without the effect ofany dividend declaration.Income Statement:Sales..............................................44,000,000COGS.............................................29,400,000Grossprofit.........................................14,600,000Operatingexpenses..................................6,000,000Operating income beforeinterest.......................8,600,000Interestexpense.....................................1,000,000Income beforetax...................................7,600,000Income tax(30%)....................................2,300,000Net income.........................................5,300,000Statement of Financial Position:Current AssetsCash..............................................4,000,000Accountsreceivable..................................5,000,000Inventory...........................................2,000,000Other..............................................3,700,000Total CurrentAssets.................................14,700,000Long-term investments................................7,000,000Property, plant and equipment(net).....................17,000,000TotalAssets........................................38,700,000Current LiabilitiesAccountspayable....................................2,000,000Accruedliabilities....................................3,000,000Other..............................................4,000,000Total CurrentLiabilities...............................9,000,000Non-currentliabilities.................................16,000,000Shareholders’ EquityCommon shares.....................................1,000,000Contributedsurplus..................................4,900,000Retained earnings (includes this year’s netincome).........7,800,000Total Shareholders’Equity.............................13,700,000Total Liabilities andEquity................................38,700,000Other information:1)Last year, the net income was $3,500,000, and $3,300,000 cashdividends were paid.2)Dumbledore has two debt agreements that call for thecorporation to maintain at least $2,500,000 in retained earnings,as well as maintain a debt-to-total-assets ratio of no more than70%.3)There has been no change in the number of shares outstandingduring the year.You start to think about the recommendations you are going tomake. It is the end of November, and historically the corporationhas declared dividends five days before the end of the year.Instructionsa)What factors will limit the amount to be distributed asdividends?b)What are important considerations in your decision? What wouldyou recommend?Provide any journal entry that is related to yourdecision.