Answer :
The retained earnings is $27,600,000.
What is retained earnings?
Retained earnings means the portion of the firm's profits retained in the business for further growth, which is not paid out as dividends to shareholders.
In this case, the retained earnings at the end of 2014 is the beginning retained earnings from 2013 plus the profits retained in the current year, which is the after-tax profits minus the dividends paid.
After-tax profits=pre-tax income*(1-marginal tax rate)
pre-tax income= $5,000,000
marginal tax rate=40%
After-tax profits=$5,000,000*(1-40%)
After-tax profits=$3,000,000
dividends=dividend per share*shares outstanding
dividend per share=$0.20
shares outstanding=2,000,000
dividends=$0.20*2,000,000
dividends=$400,000
current year retained profits=$3,000,000-$400,000
current year retained profits=$2,600,000
Total retained earnings=$25,000,000+$2,600,000
Total retained earnings=$27,600,000
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The Ending retained earnings at the end of 2014 equals $27,600,000.
What is a retained earning?
This refers to the amount of profit that a company has left over after paying all its direct costs, indirect costs, income taxes and its dividends to shareholders
In the question, we need to understand that dividends reduce retained earnings at the time they are declared even if they are not paid until the following year.
Net Income
= Pre-tax earnings x (1 - marginal tax rate)
= $5,000,000 x (1 - 40%)
= $3,000,000.
Total dividends
= Dividend / share x outstanding shares
= $0.20 x 2,000,000
= $400,000.
Ending Retained Earnings
= $25,000,000 beginning retained earnings + $3,000,000 net income - $400,000 declared dividends
= $27,600,000.
Therefore, the Ending retained earnings at the end of 2014 equals $27,600,000.
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