Question 18.2: If instead of paying out 30% of earnings as dividends, KMS d...
If instead of paying out 30% of earnings as dividends, KMS decides not to pay any dividend and instead retains all its 2016 earnings, how would its net new financing change?
Plan
KMS currently pays out 30% of its net income as dividends, so rather than retaining only $5758, it will retain the entire $8226. This will increase stockholders’ equity, reducing the net new financing.
Execute
The additional retained earnings are $8226 – $5758 = $2468. Compared to Table 18.3, stockholders’ equity will be $79,892 + $2468 = $82,360 and total liabilities and equity will also be $2468 higher, rising to $100,999. Net new financing, the imbalance between KMS’s assets and liabilities and equity, will decrease to $8396 – $2468 = $5928.
| 1 | Year | 2016 | 2017 |
| 2 | Balance Sheet ($000s) | ||
| 3 | Liabilities | ||
| 4 | Accounts Payable | 11,982 | 14,139 |
| 5 | Debt | 4,500 | 4,500 |
| 6 | Total Liabilities | 16,482 | 18,639 |
| 7 | Stockholders’ Equity | 74,134 | 82,360 |
| 8 | Total Liabilities and Equity | 90,616 | 100,999 |
| 9 | Net New Financing | 5,928 |
Evaluate
When a company is growing faster than it can finance internally, any distributions to shareholders will cause it to seek greater additional financing. It is important not to confuse the need for external financing with poor performance. Most growing firms need additional financing to fuel that growth as their expenditures for growth naturally precede their income from that growth. We will revisit the issue of growth and firm value in Section 18.4.