Question

Miami Lakes Corporation is reviewing its capital budget for the upcoming year. It has paid $4.00 dividend per share (DPS) for the past several years, and it’s shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 60% equity and 40% debt,it has 1,000,000 shares of common equity outstanding,and its net income is 9$ million. The company forecasts that it will require $10 million of fund all of its profitable projects for the upcoming year.

a. If MLC follows the residual dividend model,how much retained earnings will it need to fund its capital budget(assume no dividends payment)

Retained earnings needed:

b. If MLC follows the residual dividend model,what will be the company’s dividend per share and payout ratio for the upcoming year?

DPS(residual decedents/shares outstanding):

Payout ratio(residual dividends/net income):

c. Consider the case where MLS’s management wants to maintain the $3.50 DPS and its target capital structure,but it wants to avoid issuing new common stock. The company is willing to cut its capital budget to meet its other objectives. Assuming that the company’s projects are divisible,what will be the company’s capital budget for the next year?

Capital budget for the next year:

Answer 1

Residual dividend policy is type of dividend policy in which first company use its earnings for the capital investment in current. The amount remained after fulfilling all the obligation of capital investment, pays to shareholder as dividend.

a.

Net Income = $9 million

Weight of equity = 60%

Weight of debt = 40%

Upcoming capital project = $10 million

Retained earning need for new project = $10 million × 60%

= $6 million.

Retained earning need for new project is $6 million.

b.

Amount remains for dividend = $9 million - $6 million

= $3 million.

Number of share outstanding = 1 million.

Dividend per share = $3 million / 1 million

= $3

Dividend per share is $3.

Payout ratio = $3 / $9

= 33.33%

Payout ratio is 33.33%.,

c.

if dividend per share = $3.50

Total dividend paid = $3.50 × 1 million

= $3.50 million

Total amount remains for capital project = $9 million - $3.50 million

= $5.50 million

Total amount remains for capital project is $5.50 million.

if company does not issue new equity then maximum capital budget it can afford.

Maximum capital project = $5.50 / 60%

= $9.17 million.

Maximum capital project is $9.17 million.