Zycad has operating earnings (EBIT) of $8.6 million and annual interest expenses are $1.5 million. Zycad wishes to maintain its annual dividend of $1.00 per share on the 1,900,000 shares outstanding. The firm has a bond issue outstanding that requires the retirement of $3 million (face value) of the issue each year through purchases of the bonds in the market. What is the maximum dividend per share that may be paid if the current market price of the bonds is $85? Assume the marginal tax rate is 40% and that earnings are the only source of funds that can be used to pay the dividend and retire the bonds.
A) $0.66
B) $0.16
C) $1.37
D) $0.90

Question

Quizplus · Accepted Answer

To find the maximum dividend per share, calculate the net income after taxes and interest, then subtract the cost of retiring the bonds. EBIT is $8.6 million, interest is $1.5 million, so taxable income is $7.1 million. After 40% tax, net income is $4.26 million. The cost to retire $3 million face value of bonds at $85 is $2.55 million. Remaining funds for dividends are $1.71 million, which divided by 1.9 million shares gives a maximum dividend of $0.90 per share.

Zycad Has Operating Earnings (EBIT) of $8