In 2017, the Keenan Company paid dividends totaling $3.6 millionon net income of $10.8 million. Note that 2017 was a normal yearand that for the past 10 years, earnings have grown at a constantrate of 10%. However, in 2018, earnings are expected to jump to$14.4 million, 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—the high 2018projected earnings level is due to an exceptionally profitable newproduct line to be introduced that year—and then the company willreturn to its previous 10% growth rate. Keenan’s target capitalstructure is 40% debt and 60% equity.
a. Calculate Keenan’s total dividends for 2018 if it follows eachof the following policies:
(1)Its 2018 dividend payment is set to force dividends to grow atthe long-run growth rate in earnings.
(2) It continues the 2017 dividend payout ratio.
(3)It uses a pure residual policy with all distributions in theform of dividends (40% of the $8.4 million investment is financedwith debt and 60% with common equity).
(4)It employs a regular-dividend-plus-extras policy, with theregular dividend being based on the long-run growth rate and theextra dividend being set according to the residual 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.