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Residual Dividend Policy and Dividend Payout Ratio

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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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The solution identify various scenario pertaining to company's choice of following dividend residual policy, maintaining dividend pay out, its profitability on stockholders.

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