Sugar Cane Inc. has $800,000 in earnings and excess cash of $400,000 and is trying to decide whether to pay out these funds to its shareholders in the form of dividends or reinvest it in the company. The company has 300,000 shares outstanding and a P/E ratio of 12. If the funds are paid out in the form of dividends, it is projected that the P/E ratio will increase by 10% as the majority of its shareholders are on a fixed income and prefer to receive dividend payments in order to supplement their income. As an alternative the funds could be retained and reinvested at 15% in which case the P/E ratio would remain unchanged

Required:

1. Advise Sugar Cane Inc. what action they should take (with calcuations to support your advice). (8 marks)
2. Would your advice change if P/E ratio increased by 10% in both situations? (3 marks)

Answer rating: 100% (QA)

Recommendations Scenario 1 Payout as Dividends Payout 800000 400000 1200000 Increase in PE ratio 10 Assuming no change in earnings the new share price ... View the full answer