Question

You have recently been appointed CEO of Wizard House Ltd., a wholesale distributor of magic supplies. One day your CFO reminds you that next week you will have to make recommendations to the board of directors regarding this year’s annual dividend. This catches you totally by surprise. Luckily, the CFO was kind enough to provide you with some additional information. He shows you the projected income statement and balance sheet, without the effect of any dividend declaration.

Income Statement:

         Sales..............................................................................................................................            44,000,000

         COGS.............................................................................................................................            29,400,000

         Gross profit.................................................................................................................            14,600,000

         Operating expenses...................................................................................................             6,000,000

         Operating income before interest..........................................................................             8,600,000

         Interest expense........................................................................................................             1,000,000

         Income before tax......................................................................................................             7,600,000

         Income tax (30%).......................................................................................................             2,300,000

         Net income..................................................................................................................             5,300,000

Statement of Financial Position:

Current Assets

         Cash..............................................................................................................................             4,000,000

         Accounts receivable..................................................................................................             5,000,000

         Inventory.....................................................................................................................             2,000,000

         Other............................................................................................................................             3,700,000

         Total Current Assets..................................................................................................            14,700,000

         Long-term investments.............................................................................................             7,000,000

         Property, plant and equipment (net).....................................................................            17,000,000

         Total Assets.................................................................................................................            38,700,000

Current Liabilities

         Accounts payable.......................................................................................................             2,000,000

         Accrued liabilities.......................................................................................................             3,000,000

         Other............................................................................................................................             4,000,000

         Total Current Liabilities.............................................................................................             9,000,000

         Non-current liabilities................................................................................................            16,000,000

Shareholders’ Equity

         Common shares.........................................................................................................             1,000,000

         Contributed surplus...................................................................................................             4,900,000

         Retained earnings (includes this year’s net income)...........................................             7,800,000

         Total Shareholders’ Equity........................................................................................            13,700,000

Total Liabilities and Equity.................................................................................................            38,700,000

Other information:

1)      Last year, the net income was $3,500,000, and $3,300,000 cash dividends were paid.

2)      Wizard House has two debt agreements that call for the corporation to maintain at least $2,500,000 in retained earnings, as well as maintain a debt-to-total-assets ratio of no more than 70%.

3)      There has been no change in the number of shares outstanding during the year.

You start to think about the recommendations you are going to make. It is the end of November, and historically the corporation has declared dividends five days before the end of the year.

Instructions

a)      What factors will limit the amount to be distributed as dividends?

b)      What are important considerations in your decision? What would you recommend? Provide any journal entry that is related to your decision.

Answer 1

Wizard House Ltd Que Following are the factors that will limit the amount to be distributed as dividends : 1.) Ensure that debt to total assets ratio shall be less than for affere dividend distribution given in Other Information ) 27 Maintain at least retained earning distribution $25,00, 000 in after (post) dividend 3> Future growth Plans of the company. 4.7 Cost factor shall be considered Buch as to pay the debt and lowering the Corporate debt structure. 5.7 Rate after and of dividend considering the its alternate shall be stability Investment consisdered of company decisions.

B) Most Importantly, the deceision and distribution dividend shall into consideration offer considering the debt agreements which company mandatority comply with as in the question as follows :> of declaration be taken two has to highlighted 17 Debt to Total Assers Ration Shall be no more than 70% 27 $25,00,000 in Maintain Retained at least Earning. 1.7 Debt to Total Asset Ratio < 70% Total Debt = + Non-Corrent Total Current Liability liability - 9,000,000 + 16,000,000 -$25,ooo, oool- Total Asset = $38, 700, 000/- [ Given ]

Debt / Total Asset = 70% het amount to be distributed a as dividend be 25,000,000 (38,70 90 od -a) = 70% & By solving the get, above equation we o n 0.7a = 2,0go, ooo - a = $ 2,985,714,2857 - 0 27 Retained earning shall be $25,00 $ 2,500,000 Hence amount taken = can be Current Balance - Mandatory Balance - 7, doo, ooo - 2,500,000 =$5,300,00 -

From ea. O & ③ we get, can dividend be Maximum amount distributed y Debt to Asset Ratio - $2,985,714,2857 Earning = 27 Refreinod $ B300,ooo Lower of the above will be selected for distributing the amount of dividend $ 2,985, 74.2857 on =$2,985,714.00 (sounded) * Journal Entry Entry 1 Retained Earning Al Dr. 2,985,714,00 To Dividend payable Ak 2,985,714.00 dividend payrable amount due Dr. 2,985,714.00 Ak 2,985,714.00 Entry 2 Dividend payable Al To Cash / Bank [Being dindend Paid
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