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Residual Dividend Policy

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The following facts apply to your company:
Target capital structure: 50% debt; 50% equity.

EBIT: $200,000,000
Assets: $500,000,000
Tax Rate: 40%
Cost of new & old debt 8%

Based on the residual distribution policy (with all distributions in
the form of dividends), the payout ratio is 60 percent.
How large (in millions of dollars) will the capital budget be?

Needs some guidance on capital budgeting

less interest = $20,000,000 = ($500,000,000 * 50%) * 8%
EBT = $180,000,000 = $500,000,000 - $20,000,000
Net Income = EBIT - less interest - Taxes
Net Income = $108,000,000 = $180,000,000 - ($180,000,000 * 40%)

Distribution = 60%
Target equity ratio = $250,000,000

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The net income is calculated correctly.
From the net income, dividends will be 60%= 108,000,000X0.6=64,800,000 and the retained earnings will be 108,000,000-64,800,000=43,200,000

We are to find the amount of capital budget. The total capital budget will be ...

Solution Summary

The solution explains how to determine the capital budget based on a residual dividend policy

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Residual dividend policy and various scenarios

Mary's Mugs is evaluating its dividend policy. What would the differences be with a residual policy vs cash dividends?

Capital budget $10,000,000
Desired capital structure Debt 40% Equity 60%
Expected net income $7,000,000
Outstanding shares 5,000,000
Last annual dividend per share $0.50

1. If the company follows a residual policy, how much will it pay out in dividends?
2. If the company decides to maintain last year's dividend, how much will it pay out in dividends this year?
3. What options are available for the company for raising funds needed for the capital budget?
4. Will it be a good idea for the company follow the residual dividend policy? Why or why not?
5. Which is more profitable for the stockholder, cash dividends or stock repurchases? Why?

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