Question

1) The Garlington Corporation expects next year’s net income to be $15 million. The firm’s debt/assets ratio currently is 40 percent. Garlington has $12 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual dividend policy, how large should Garlington’s dividend payout ratio be next year?

2. Last year, Axel Tires retained $180,000 of the $450,000 net income it generated. This year, Axel generated net income equal to $510,000. If Axel follows the constant dividend payout ratio dividend policy, how much should be paid in dividends this year?

Answer 1

1)Equity ratio = 1-.40 = .60 or 60%

Distribution = Net income - [Target equity ratio *total capital budget)

                   = 15,000,000- [.60 * 12,000,000]

                     = 15,000,000 -7,200,000

                     = 7,800,000

Dividend payout =dividend /net income

         = 7800000/15000000

         = .52 or 52%

2)

Dividend payout ratio for last year =dividend /net income

                                      = 270000 / 450000

                                       = .60 or 60%

**Dividend paid = 450000-180000= 270000

Dividend paid this year = 510000*.60 = $ 306000