Question

​(Residual dividend policy​) ​FarmCo, Inc. follows a policy of paying out cash dividends equal to the...

​(Residual dividend policy​)

​FarmCo, Inc. follows a policy of paying out cash dividends equal to the residual amount that remains after funding 40

percent of its planned capital expenditures. The firm tries to maintain a 40 percent debt and 60 percent equity capital structure and does not plan on issuing more stock in the coming year.​ FarmCo's CFO has estimated that the firm will earn $17

million in the current year.

a. If the firm maintains its target financing mix and does not issue any equity next​ year, what is the most it could spend on capital expenditures next year given its earnings​ estimate?

b. If​ FarmCo's capital budget for next year is $13 ​million, how much will the firm pay in dividends and what is the resulting dividend payout​ percentage?

a. If the firm maintains its target financing mix and does not issue any equity next​ year, what is the most it could spend on capital expenditures next year given its earnings​ estimate?

​$ million ​ (Round to two decimal​ places.)

b. If​ FarmCo's capital budget for next year is $13 ​million, how much will the firm pay in​ dividends?

​$ million ​ (Round to one decimal​ place.)

What is the resulting dividend payout​ percentage?

% ​ (Round to two decimal​ places.)

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Homework Answers

Answer #1

Answer:

a. Since the Farm Co. follows residual dividend payout policy, 60% of the investment comes from retained earnings. The earnings of the firm is $17 million, so the most it could spend on capital expenditures next year given its earnings​ estimate is:

$17/0.60 =

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b. When the earnings of the firm is $13 million, the company will allow 60% of the amount from equity. Therefore, 13 million - $13 million x 0.60 = $13 million - $7.8 million = $5.2 million is paid as dividends. Therefore, the resulting payout percentage is:

$5.2/$17 =

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