Question
In: Finance
Residual dividend policy. As president of Young's of California, a large clothing chain, you have just...
Residual dividend policy. As president of Young's of California, a large clothing chain, you have just received a letter from a major stockholder. The stockholder asks about the company's dividend policy. In fact, the stockholder has asked you to estimate the amount of the dividend that you are likely to pay next year. You have not yet collected all the information about the expected dividend payment, but you do know the following:
(1) The company follows a residual dividend policy.
(2) The total capital budget for next year is likely to be one of three amounts, depending on the results of capital budgeting studies that are currently underway. The capital expenditure amounts are $2 million, $3 million, and $4 million.
(3) The forecasted level of potential retained earnings next year is $2 million.
(4) The target or optimal capital structure is a debt ratio of 45%. You have decided to respond by sending the stockholder the best information available to you.
a. Compute the amount of the dividend (or the amount of new common stock needed) and the dividend payout ratio for each of the three capital expenditure amounts.
b. Compare, contrast, and discuss the amount of dividends (calculated in part a) associated with each of the three capital expenditure amounts.
Solutions
Expert Solution
| Under residual dividend policy, earnings available after meeting all profitable projects are distributed as dividends | |||
| Capex | 2,000,000 | 3,000,000 | 4,000,000 |
| To be financed throught Equity 55% | 1,100,000 | 1,650,000 | 2,200,000 |
| Net Income | 2,000,000 | 2,000,000 | 2,000,000 |
| Dividends = Net Income- To be financed through Equity | 900,000 | 350,000 | 0 |
| Payout ratio = Dividend/Earnings | 45.00% | 17.50% | 0.00% |
| Higher the capital expenditure, lower will be the dividends and hence, lower will be the payout ratio |
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California, a large clothing chain, you have just received a
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company's dividend policy. In fact, the stockholder has asked you
to estimate the amount of the dividend that you are likely to pay
next year. You have not yet collected all the information about the
expected dividend payment, but you do know the following:
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Residual dividend policy As president of Young's of California, a large clothing chain, you have just...
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dividend policy. In fact, the stockholder has asked you to estimate
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about the company's dividend policy. In fact, the stockholder has
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likely to pay next year. You have not yet collected all the
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received a letter from a major stockholder. The stockholder asks
about the company's dividend policy. In fact, the stockholder has
asked you to estimate the amount of the dividend that you are
likely to pay next year. You have not yet collected all the
information about the expected dividend payment, but you do know
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