Tredegar Industries Inc. makes plastic films and molded plastic products and soft alloy aluminum extrusions, distributes business applications software, and provides proprietary chemistry services. A note to the company’s annual report states: While certain of the Company’s subsidiaries’ debt facilities are outstanding, the Company’s subsidiaries must meet specific financial tests on an ongoing basis, which are customary for these types of facilities. Except as provided by applicable corporate law, there are no restrictions on the Company’s ability to pay dividends from retained earnings. However, the payment of cash dividends by the Company’s subsidiaries to the Company are subject to certain restrictions under the terms of various agreements covering the Company’s subsidiaries’ long-term debt. Toledo, PDI, and Bal Crank [three of Tredegar’s subsidiaries] are not permitted under each subsidiary’s respective debt agreements to pay cash dividends. Assuming certain financial covenants are met, General Chemical [another subsidiary] is permitted to pay cash dividends of up to 50% of the net income (subject to certain adjustments) of General Chemical for the applicable period. Consequently, the Company’s ability to pay cash dividends on Common Stock may effectively be limited by such agreements. At [year end] approximately $51,000 was available for dividend payments in accordance with these covenants. The company’s financial statements showed net income of $45,035, dividends of $3,176, and year-end retained earnings of $99,027. (All dollar amounts here and in the note are in thousands.)
1. Explain why and how lenders restrict a subsidiary’s ability to pay dividends to the parent corporation.
2. What was Tredegar’s dividend payout ratio?
3. What is the maximum amount of dividends the company could have paid to common stockholders in the year without violating the terms of its lending agreements?
4. Suppose that Tredegar’s loan agreements contained no restrictions on dividend payments by subsidiaries or the parent company. What is the maximum legal amount of dividends the company could have paid to common stockholders?
5. Do contractual or legal restrictions on dividend payments seem to be influencing the company’s dividend policy?
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