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Residual Dividend Policy for Old`s California

3. As a financial manager for Old's California, you have the following information:

a) The company follows a residual dividend policy;
b) The total capital budget for next year is likely to be $5 million;
c) The forecasted level of potential retained earnings next year is $8million;
d) The target or optimal capital structure is a debt ratio of 50%;

Please answer the following questions:

3a. Describe a residual dividend policy.

3b. Compute the amount of the dividend (or the amount of new common stock needed).

3c. Compute the dividend pay-out ratio.

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4. A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock is 15 percent, and if investors require a 19 percent rate of return, what is the price of the stock?

Solution Preview

3a. Describe a residual dividend policy.

A residual dividend policy is a passive dividend policy. The dividend amount is decided by subtracting the amount of equity needed for new investments from the net income. This amount is distributed as dividends.
Amount of dividend = Net Income - Equity needed for investment ...

Solution Summary

The solution explains the residual dividend policy and the calculation of the dividend amount

$2.19