BRET COMPANY

Case on Dividend Policy

Bret Company is considering four investment opportunities. The required investment outlays
and expected required rates of return of these investments are shown below. The firm’s cost of
capital is 14%. The investments are to be financed by 40% debt and 60% equity. Internally
generated funds totaling P750,000 are available for reinvestments.

Required:

a. Which investments should be accepted? According to the residual dividend policy

what amount of dividends should be paid?
The investments that should be accepted are investments A, B, and C because these
provide an IRR that is greater than the cost of capital which is 14%.
The amounts of dividends that should be paid under the residual dividend policy are
those only left after the fulfillment of the capital requirements. The total cost of investments in
the three accepted investments is amounting to P1,150,000 wherein only 60% of it will be paid
through equity capital. The P690,000 funds needed will be from the P750,000 internally
generated funds available for reinvestments. So the amount of the dividends to be paid is
P60,000 which is the available funds left.

Investment Investment Cost

A 275,000

B 325,000
 C 550,000

Total Cost 1,150,000

60%

P690,000

Remaining funds available for dividends = P750,000 - P 690,000

= P60,000

b. Assuming that the cost of capital is 10% instead of 14% which investments should be
accepted? According to the residual dividend policy what amount of dividends should be
paid?
If the cost of capital will be 10% then all of the investments (Investments A, B, C, and D.)
should be accepted because their IRR is greater than the cost of capital.
The total cost of the four investments is P1,550,000 of which 60% or the P930,000 of the
needed funds will come from the equity capital. There is no amount of dividends that should be
paid because there is no amount left after undertaking all those acceptable investment
opportunities. There is even a lack of equity capital to finance the 60% amount of the total
investment costs. Due to the financial trouble or the large costs from the investment
opportunities the company may suspend the dividend payments in order to protect its reserve
funds for future expenses.

Investment Investment Cost

A 275,000

B 325,000
C 550,000

D 400,000

Total cost 1,550,000

60%

P930,000

Remaining funds available for dividends = P750,000 - P930,000

= -P180,000

c. Discuss the different dividend policies the company can employ. What are the
advantages and disadvantages of each of these methods?

● constant-payout ratio dividend policy

Advantages
1. Indicates how much dividend will be given based on a percentage of each dollar
earned
2. Gives the company flexibility in giving dividends based on market conditions.
3. There is no fixed amount of dividend given to shareholders, only a percentage
proportional to the amount they have earned during the period.

Disadvantages
1. If the earnings for the period is low or there is a decrease in profit, shareholders
dividend will also decrease.
2. Once the dividends given to shareholders decrease, the market price of the stock
price will be affected.
3. Low Payout when the business has only started operating compared to mature
businesses

● regular dividend policy

 Advantages
1. It leads to stability in terms of the market prices of shares that’s why most
shareholders prefer this dividend policy.
2. The prestige and credit rating of the company will be enhanced under this policy.
3. Uncertainties of investors about dividend payments will be easily eliminated.
4. Beneficial in assisting the company to fulfill or meet the needed financial
requirements from the retained earnings.
5. It is an essential policy because it provides a source of regular source of income
to investors

Disadvantages
1. A big possibility of those companies that pay regular dividends to have less
money to enhance and grow their business.

● low-regular-and extra dividend policy

Advantages
1. It able to help avoid giving shareholders false hopes
2. Companies can pay a constant amount of dividends regularly without default.
3. It may become a regular practice in which shareholders keep getting some
dividends.
4. Suitable for business with cyclical or seasonal earnings
5. Shareholders earn extra when business is in peaks season

Disadvantages
1. Low dividend payout on regular business events
2. Shareholders may get impatient waiting for a seasonal period
3. Extra dividends cannot be given regularly

d. What dividend policy do you recommend Bret Company should use? Why?

The IRR that Bret company can have through the following investments are far higher
than its cost of capital so it is cost-effective to apply the regular dividend policy because the
company is capable of regular payments of dividends to its shareholders. Regular dividend
policy will be significant in raising additional finances for Bret company because it helps to
provide certainty to pay dividends regularly to shareholders. It will result in more prospective
investors being interested to invest their money in the company through purchasing new
additional shares of the company. With this, the company can enhance and raise its additional
finance easily with the issuance of additional shares.

Group 3 Members:

Precy Casero
Jim Lester Trino
Blas Nolasco
Rhona Joy Tulio