Dividend Payout. The Xylon Company has experienced rapid growth in the past 5 years. In order to finance the growth, the board of directors has followed a policy of controlled borrowing, a low dividend payout ratio, and regular stock dividends
The percent of debt in the capital structure has remained constant since 20X0. The funds generated from operations have been reinvested in productive assets. Each January, for the past 4 years, Xylon’s board of directors has declared and paid a 10 percent dividend. A $0.20 per share cash dividend on the stock outstanding on June 15 has been paid each July for the past 5 years. Management estimates that the earnings for 20X7 will be $250,000. The closing price of Xylon Company’s stock at November 30, 20X7 was $25.50 per share.
The board anticipates a challenge to its intention to continue this dividend policy by two stockholders who are survivors of two of the founders. Selected data related to the company’s earnings and dividends are presented below:
Shares Outstanding as Cash Dividends Market Price per Share as of
Years Earnings ($) of December 31 Per Share ($) Total Payout ($) December 31 ($)
20X2 100,000 100,000 0.20 20,000 10.00
20X3 120,000 110,000 0.20 22,000 12.00
20X4 144,000 121,000 0.20 24,200 14.30
20X5 172,800 133,100 0.20 26,620 17.00
20X6 207,360 146,410 0.20 29,282 22.00
Prepare a response from the perspective of Xylon Company’s board of directors which (a) justifies the low cash dividend payout, and (b) rationalizes the use of stock dividends. (CMA, adapted.)