Corporate Financial Accounting 14th Edition by Carl Warren,James Reeve,Jonathan Duchac

Exercise 14

Communication
Motion Designs Inc. has paid quarterly cash dividends since 20Y7. These dividends have steadily increased from $0.05 per share to the latest dividend declaration of $0.50 per share. The board of directors would like to continue this trend and is hesitant to suspend or decrease the amount of quarterly dividends. Unfortunately, sales dropped sharply in the fourth quarter of 20Y8 due to worsening economic conditions and increased competition. As a result, the board is uncertain as to whether it should declare a dividend for the last quarter of 20Y8.
On October 1, 20Y8, Motion Designs Inc. borrowed $4,000,000 from Valley National Bank to use in modernizing its retail stores and to expand its product line in response to changes in its industry. The terms of the 10-year, 6% loan require Motion Designs to:
? Pay monthly interest on the last day of the month.
? Pay $400,000 of the principal each October 1, beginning in 20Y9.
? Maintain a current ratio (current assets ÷ current liabilities) of 2.
? Maintain a minimum balance (a compensating balance) of $100,000 in its Valley National Bank account.
On December 31, 20Y8. $1,000,000 of the $4,000,000 loan had been disbursed in modernization of the retail stores and in expansion of the product line. Motion Designs Inc.'s balance sheet as of December 31, 20Y8, follows:

The bond of directors is scheduled to meet January 10, 20Y9, to discuss the results of operations for 20Y8 and to consider the declaration of dividends for the fourth quarter of 20Y8. The chairman of the board, Lord Matt Cengage, has asked for your advice on the declaration of dividends.
Write a brief memo to the chairman of the board, outlining the factors that the board should consider to deciding whether to declare a cash dividend.