Question

In: Accounting

Distributions to Shareholders: Residual Dividend Model When a firm is deciding how much cash to distribute...

Distributions to Shareholders: Residual Dividend Model

When a firm is deciding how much cash to distribute to stockholders, it should consider two things: (1) The overriding objective is to maximize shareholder value and (2) the firm's cash flows belong to shareholders, so income shouldn't be retained unless management can reinvest those earnings at higher rates of return than shareholders can earn themselves. The -Select-capital budgetingcapital structureresidual dividendItem 1 model sets the dividend paid equal to net income minus the amount of retained earnings necessary to finance the firm's optimal capital budget. It can be expressed in equation format as:

Dividends = Net income - [(Target equity ratio)(Total capital budget)]

Because investment opportunities and earnings will vary from year to year, strict adherence to this model would result in fluctuating, unstable dividends. However, investors prefer stable, dependable dividends. Consequently, firms should use this model to help set their long-run target payout ratios, but not as a guide to the payout in any one year.

Quantitative Problem: Lane Industries is considering three independent projects, each of which requires a $2.6 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here:

Project H (high risk): Cost of capital = 16% IRR = 18%
Project M (medium risk): Cost of capital = 9% IRR = 7%
Project L (low risk): Cost of capital = 6% IRR = 7%

Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 40% debt and 60% common equity, and it expects to have net income of $3,900,000. If Lane establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to 2 decimal places.
%

Solutions

Expert Solution

SOLUTION-

(KINDLY UPVOTE PLEASE, I WILL BE GRATEFUL)


Related Solutions

When a firm is deciding how much cash to distribute to stockholders, it should consider two...
When a firm is deciding how much cash to distribute to stockholders, it should consider two things: (1) The overriding objective is to maximize shareholder value and (2) the firm's cash flows belong to shareholders, so income shouldn't be retained unless management can reinvest those earnings at higher rates of return than shareholders can earn themselves. The model sets the distribution paid equal to net income minus the amount of retained earnings necessary to finance the firm's optimal capital budget....
When a firm is deciding how much cash to distribute to stockholders, it should consider two...
When a firm is deciding how much cash to distribute to stockholders, it should consider two things: (1) The overriding objective is to maximize shareholder value and (2) the firm's cash flows belong to shareholders, so income shouldn't be retained unless management can reinvest those earnings at higher rates of return than shareholders can earn themselves. The-Select-capital budgetingcapital structureresidual distributionItem 1 model sets the distribution paid equal to net income minus the amount of retained earnings necessary to finance the...
When a firm is deciding how much cash to distribute to stockholders, it should consider two...
When a firm is deciding how much cash to distribute to stockholders, it should consider two things: (1) The overriding objective is to maximize shareholder value and (2) the firm's cash flows belong to shareholders, so income shouldn't be retained unless management can reinvest those earnings at higher rates of return than shareholders can earn themselves. The model sets the distribution paid equal to net income minus the amount of retained earnings necessary to finance the firm's optimal capital budget....
tasmania helicopters wishes to distribute $15,000 of its earnings to its shareholders. It is deciding whether...
tasmania helicopters wishes to distribute $15,000 of its earnings to its shareholders. It is deciding whether to do this through the payment of dividends or through a share repurchase. tasmania helicopters currently has 4,000 shares outstanding with a stock price of $60 per share. Its current EPS is $3. Ignore taxes and other imperfections in answering parts (a) and (b). Evaluate the two alternatives in terms of the effect on the price per share of the stock and shareholder wealth....
Is it possible for a firm to have too much cash? Why would shareholders care if...
Is it possible for a firm to have too much cash? Why would shareholders care if a firm accumulates large amounts of cash? What options are available to a firm if it believes it has too much cash? How about too little? Provide real world examples
Is it possible for a firm to have too much cash? Why would shareholders care if...
Is it possible for a firm to have too much cash? Why would shareholders care if a firm accumulates large amounts of cash? What options are available to a firm if it believes it has too much cash? How about too little?
Is it possible for a firm to have too much cash? Why would shareholders care if...
Is it possible for a firm to have too much cash? Why would shareholders care if a firm accumulates large amounts of cash? Cite your text.
Suppose that Apple announced it would distribute $100 billion to shareholders in the form of cash...
Suppose that Apple announced it would distribute $100 billion to shareholders in the form of cash dividends or stock repurchases. A tax-conscious investor in a high tax bracket would likely: a. prefer a high dividend payout, because taxes on dividends can be deferred until the stock is sold. b. prefer stock repurchases, because of the choice to sell shares back or not; plus, the tax rate on capital gains is capped and the tax is deferred until the stock is...
Dungeoness Corporation has excess cash of $2,800 that it would like to distribute to shareholders as...
Dungeoness Corporation has excess cash of $2,800 that it would like to distribute to shareholders as an extra dividend. Current earnings are $0.90 per share, and the stock currently sells for $40 per share. There are 210 shares outstanding. Ignore taxes and other imperfections. If Dungeoness Corp. pays a cash dividend, what will be the dividend per share? After the dividend is paid, what will the price per share be? What are earnings per share (EPS) and the price earnings...
A cash distribution of earnings by a corporation to its shareholders is a cash dividend. Although...
A cash distribution of earnings by a corporation to its shareholders is a cash dividend. Although dividends may be paid in other assets, cash dividends are the most common. What are the three conditions for a cash dividend and explain the advantages and disadvantages of cash dividends? Also, describe the three dates included in a dividend announcement and the journal entries involved?
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT