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Unit 14: Management of Surplus & Dividend Policy

Self Assessment Notes

Fill in the blanks:
13. The amount of dividend that can be legally distributed is governed by the …………….law.
14. With ……………………approach, the firm recognizes that the payment of dividends has a
strong influence on the market price of the common shares.
15. Dividend warrants must be posted within …… days of the declaration date.



Case Study Case: Ramesh Products

This case allows the reader to apply the concept of future EPS in evaluating a course of
action in terms of its effect on the market value of the firm’s common stock.
Ramesh Products (RKP) is a medium-sized producer of chemicals and vinyl coating used
in a variety of industrial processes. The company’s main facilities are located in an industrial
park in East Baltimost, a central site by a rail line that is linking the firm with its major
customers on the east coast.

Last year the firm recorded over $200 million in sales, showed a net income of $53 million
and concluded a very successful year. For the coming year, the firm expects a 15 per cent
improvement in sales and operating income figures.
The firm’s management committee, consisting of the president and the vice-presidents of
production, marketing, and finance, will be meeting with in a week to discuss a major new
activity for the next year. Products has been invited to bid on a long-term contract to
produce a line of plastics for a large chemical company in Wilmington, Delaware. It
appears that the firm can easily get the $50 million contract which should yield an additional
$14 million in operating income. These figures are for next year only, and the firm estimates
even higher sales and profits in the future.
Chowdhary vice-president of finance, has been studying the financial data related to the
new line of plastics. The production manager knows of a small plastic company located
about three miles from RKP’s facilities. The plastics company has all the equipment needed
to produce the new line of plastics; the company is for sale for $104 million. This price
represents largely the value of the assets, since the company has lost its only large contracts.
Chowdhary Prasad has discussed the purchase of this plastics company with a local real
estate agent and has confirmed that it is available for $100 million.
Chowdhary Prasad figures that RKP has sufficient working capital to add the new plastics
line but does not have the cash to buy the 100 million of machinery and equipment needed
to begin the production. Discussion with a representative of a large Baltimore bank reveals
that RKP can borrow $39 million through a 12 per cent mortgage on its main facilities. A
mortgage company has indicated that it would help finance the plastic machinery with a
$51 million, 13.6 per cent mortgage. Chowdhary Prasad is considering these choices but
knows that RKP has traditionally kept its debt-asset ratio below 41 per cent. He does not
want to borrow if the additional debt causes the ratio to exceed 41 per cent.
Chowdhary Prasad discussed equity financing with RKP’s investment banker on a recent
trip to New Jersy City.He learned that the firm could probably issue upto $150 million in
15 per cent preferred stock or class A common stock. If the common stock were offered, it
Contd...

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