This is a more difficult but informative problem. James Brodrick & Sons, Inc. is growing rapidly and, if at all possible, would like to finance its growth without selling new equity. Selected information from the companys five-year financial forecast follows.

a. According to this forecast, what dividends will the company be able to distribute annually without raising new equity and while maintaining a balance of $200 million in marketable securities? What will the annual dividend payout ratio be? (Hint: Remember sources of cash must equal uses at all times.)

b. Assume the company wants a stable payout ratio over time and plans to use its marketable securities portfolio as a buffer to absorb year-to-year variations in earnings and investments. Set the annual payout ratio equal to the five-year sum of total dividends paid determined in question (a) divided by total earnings. Then, solve for the size of the companys marketable securities portfolio each year.

c. Suppose earnings fall below forecast every year. What options does the company have for continuing to fund its investments?

Year Earnings after tax ($ millions) Capital Investment ($ millions) Target book value debt-to-equity ratio (%) Dividend payout ratio (%) Marketable securities ($ millions) (Year O marketable securities = $200 million.) 1 2 3 4 5 100 130 170 230 300 175 300 300 350 440 120 120 120 120 120 ? ? ? ? ? 200 200 200 200 200 Year Earnings after tax ($ millions) Capital Investment ($ millions) Target book value debt-to-equity ratio (%) Dividend payout ratio (%) Marketable securities ($ millions) (Year O marketable securities = $200 million.) 1 2 3 4 5 100 130 170 230 300 175 300 300 350 440 120 120 120 120 120 ? ? ? ? ? 200 200 200 200 200