In 2017, Keenan Company paid dividends totaling $3,600,000 onnet income of $10.8 million. Note that 2017 was a normal year andthat for the past 10 years, earnings have grown at a constant rateof 10%. However, in 2018, earnings are expected to jump to $14.4million and the firm expects to have profitable investmentopportunities of $8.4 million. It is predicted that Keenan will notbe able to maintain the 2018 level of earnings growth because thehigh 2018 earnings level is attributable to an exceptionallyprofitable new product line introduced that year. After 2018, thecompany will return to its previous 10% growth rate. Keenan’starget capital structure is 40% debt and 60% equity.

a. Calculate Keenan’s total dividends for 2018 assuming that itfollows each of the following policies: 1. Its 2018 dividendpayment is set to force dividends to grow at the long-run growthrate in earnings. 2. It continues the 2017 dividend payout ratio.3. It uses a pure residual dividend policy (40% of the $8.4 millioninvestment is financed with debt and 60% with common equity). 4. Itemploys a regular-dividend-plus-extras policy, with the regulardividend being based on the long-run growth rate and the extradividend being set according to the residual dividend policy.

b. Which of the preceding policies would you recommend? Restrictyour choices to the ones listed but justify your answer.

c. Assume that investors expect Keenan to pay total dividends of$9,000,000 in 2018 and to have the dividend grow at 10% after 2018.The stock’s total market value is $180 million. What is thecompany’s cost of equity?

d. What is Keenan’s long-run average return on equity?

e. Does a 2018 dividend of $9,000,000 seem reasonable in view ofyour answers to parts c and d? If not, should the dividend behigher or lower? Explain your answer.