In 2015, the Sirmans Company paid dividends totaling $3,600,000 on net income of $10.8 million. The year 2015 was a normal one for the company, and for the past 10 years, earnings have grown at a constant rate of 10 percent. In 2016, earnings are expected to jump to $14.4 million, and the firm expects to have profitable investment opportunities of $8.4 million. It is predicted that Sirmans will not be able to maintain the 2016 level of earnings growth—the high 2016 earnings level is attributable to an exceptionally profitable new product line introduced that year—and the company will return to its previous 10 percent growth rate. Sirmans’s target debt/assets ratio is 40 percent. 

a. Calculate Sirmans’s total dividends for 2016 if it follows each of the following policies:

(1) Its 2016 dividend payment is set to force dividends to grow at the long- run growth rate in earnings.

(2) It continues the 2015 dividend payout ratio.

(3) It uses a pure residual dividend policy (40 percent of the $8.4 million investment is financed with debt).

(4) It employs a regular-dividend-plus-extras policy. The regular dividend is based on the long-run growth rate and the extra dividend is set according to the residual policy.

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

c. Assume that investors expect Sirmans to pay total dividends of $9 million in 2016 and to have the dividend grow at 10 percent after 2016. The total market value of the stock is $180 million. What is the company’s cost of equity?