You are considering purchasing some Stanley Ltd. common shares. Although Stanley recently had to make heavy expenditures for new capital assets, the company has been relatively profitable over the years and prospects for the future look good. The summarized statement of financial position at the end of 2010 is as follows:
Cash……………………………………………. $ 37,500
Other current assets…………………………….. 740,500
Capital assets (net)……………………………… 4,702,000
Total……………………………………………...$5,480,000
Current liabilities………………………………… $ 414,000
Long-term debt………………………………….. 2,000,000
Share capital, common shares…………………… 1,000,000
Retained earnings………………………………... 2,066,000
Total………………………………………………$5,480,000
The company has 150,000 common shares outstanding, and its earnings per share have increased by at least 10% in each of the last 10 years. In several recent years, earnings per share increased by more than 14%. Given the company’s earnings and the amount of retained earnings, you judge that it could easily pay cash dividends of $3 or $4 per share, resulting in hardly a dent in retained earnings.
Required:
a. Discuss whether it is likely that you would receive a cash dividend from Stanley during the next year if you were to purchase its shares.
b. Discuss whether it is likely that you would receive a cash dividend from Stanley during the next five years if you were to purchase its shares.
c. In making an investment decision, would it help you to know whether Stanley has paid dividends in the past? Explain.
d. Suppose Stanley borrowed $2 million cash on a five-year bank loan to provide working capital and additional operating flexibility. While no collateral would be required, the loan would stipulate that no dividends be paid in any year in which the ratio of long-term debt to equity was greater than 60%.
i. If Stanley were to enter into the loan agreement, would you be likely to receive a dividend next year?
ii. Would you be likely to receive a dividend at some point in the next five years? (Hint: What would you expect to happen to the statement of financial position values for long-term debt and for equity?)