In this workout, we're being asked to calculate the maximum amount of dividends that the owners of the holding company can receive.

We're gonna ignore taxes for simplicity.

Let's take a look at the holding company.

The main asset of the holding company is an investment in equity in the operating company, and they also have an investment in a subordinated loan in the operating company.

The operating company, which contains the project and the cash flows from that project in this case, has retained earnings of negative 40.

Now keep in mind, this is the balance sheet.

As of the beginning of the year, during the year, the operating company is gonna generate earnings before interest and taxes of 50.

So let's begin by calculating the net income of the operating company during that year.

First, let's compute the interest that the operating company will pay the holding company on the subordinated loan, and that will be equal to the 90 debt balance times 20% interest.

So now we can calculate the net income as simply earnings before interest and taxes minus the interest payment, and that would give us 32.

Now, notice that the net income during the year is not enough to make the companies retained earnings balance positive.

The net income is 32, while the retain earnings balance at the beginning of the year is negative 40.

So this means that the operating company is not able to pay any dividends to the holding company.

So let's calculate the amount of dividends.

In this case, we're gonna use a max function between zero and the sum of the net income and the retain earnings.

Of course, if you take a net income of 32 plus the retain earnings of negative 40, you get negative 8.

Therefore, the max function will give you a zero, which is the most dividends that the operating company can pay the holding company. Now, the amount of dividends the holding company can pay its own shareholders will come from the cash flows received from the operating company.

And in this case, we can compute that as simply the sum of the interest received as well as the dividends received, and that will be 18.

Now, keep in mind that using this structure, the holding company is able to extract more value from the operating company.

If we did not have a subordinated loan and the interest would be zero, then the most that the operating company could pay the holding company would be 10 in dividends, and we can take a look at that here.

Let's simply replace the 18 interest amount with a hardcoded 0, basically assuming that there is no interest because there is no subordinated loan.

If that's the case, now, the max dividends that the operating company can pay, the holding company would be 10, which is simply the sum of the net income of 50 and the retained earnings of negative 40.

Therefore, the dividends of the holding company to its shareholders will only be able to reach 10.