Question

Residual Distribution Model

Puckett Products is planning for $2.4 million in capital expenditures next year. Puckett's target capital structure consists of 45% debt and 55% equity. If net income next year is $2.7 million and Puckett follows a residual distribution policy with all distributions as dividends, what will be its dividend payout ratio? Round your answer to two decimal places.

Residual Distribution Policy

Petersen Company has a capital budget of $1.2 million. The company wants to maintain a target capital structure which is 70% debt and 30% equity. The company forecasts that its net income this year will be $500,000. If the company follows a residual distribution model and pays all distributions as dividends, what will be its payout ratio? Round your answer to two decimal places.

Answer 1

According to residual dividend distribution model, company management uses to fund capital expenditures with available earnings before paying dividends to shareholders

Puckett Products

Capex plan for next year =$2.4mil. This would be funded in the proportion of company's capital structure currently, i.e., 45% debt and 55% equity.

55% of $2.4 mil = $1.32 mil.

$1.32 mil is to be financed from net income that the company earns.

Company is projected to earn $2.7 mil. Out of this $1.32 mil is needed for capex funding. Rest would be paid as dividend, i.e., $1.38 mil

Hence dividend payout ratio = 1.38/2.7 = 51.11%

Peterson Company

Capex plan for next year =$1.2 mil. This would be funded in the proportion of company's capital structure currently, i.e., 70% debt and 30% equity.

30% of $1.2 mil = $0.36 mil.

$0.36 mil is to be financed from net income that the company earns.

Company is projected to earn $0.5 mil. Out of this $0.36 mil is needed for capex funding. Rest would be paid as dividend, i.e., $0.14 mil

Hence dividend payout ratio = 0.14/0.5 = 28.00%