The Altern Music Co. earns $4.25 per share, has 70,000 shares outstanding, and a capital budget of $200,000. If Altern Music raises all its funds internally and follows the "passive residual policy," what are the annual dividends per share?

Question

Quizplus · Accepted Answer

The first step is to calculate the total earnings of the company:
Total earnings = Earnings per share x Number of shares outstanding
Total earnings = $4.25 x 70,000
Total earnings = $297,500

Next, we need to calculate the amount of earnings needed to fund the capital budget:
Earnings needed for capital budget = Capital budget / (1 - Dividend payout ratio)
Assuming a dividend payout ratio of 60% (based on the passive residual policy), we get:
Earnings needed for capital budget = $200,000 / (1 - 0.6)
Earnings needed for capital budget = $500,000

To find the amount of earnings available for dividends, we subtract the capital budget from the total earnings:
Earnings available for dividends = Total earnings - Earnings needed for capital budget
Earnings available for dividends = $297,500 - $500,000
Earnings available for dividends = -$202,500

Since we don't have enough earnings to cover the entire capital budget, we can't pay any dividends. However, if we divide the negative amount by the number of shares outstanding, we get the annual dividends per share:
Annual dividends per share = Earnings available for dividends / Number of shares outstanding
Annual dividends per share = -$202,500 / 70,000
Annual dividends per share = -$2.89

Since a negative dividend makes no sense, the answer is that the company cannot pay any dividends. Therefore, the best choice is B, as the other choices include dividend amounts that can't be paid.