This case is based on the statement of cash flows for Allison Corporation, illustrated in Exhibit 13–1 . Use this statement to evaluate the company’s ability to continue paying the current level of dividends—$40,000 per year. The following information also is available:
1. The net cash flows from operating activities shown in the statement are relatively normal for Allison Corporation. Net cash flows from operating activities have not varied by more than a few thousand dollars in any of the past three years.
2. The net outflow for investing activities was unusually high, because the company modernized its production facilities during the year. The normal investing cash outflow is about $45,000 per year, the amount required to replace existing plant assets as they are retired. Over the long run, marketable securities transactions and lending transactions have a very small impact on Allison’s net cash flows from investing activities.
3. The net cash flows from financing activities were unusually large in the current year because of the issuance of bonds payable and capital stock. These securities were issued to finance the modernization of the production facilities. In a typical year, financing activities include only short-term borrowing transactions and payments of dividends.
a. Solely on the basis of the company’s past performance, do you believe that the $40,000 annual dividend payments are secure? That is, does the company appear able to pay this amount in dividends every year without straining its cash position? Do you think it more likely that Allison Corporation will increase or decrease the amount of dividends that it pays? Explain fully.
b. Should any of the unusual events appearing in the statement of cash flows for the current year affect your analysis of the company’s ability to pay future dividends? Explain.
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