Question

Residual Distribution Policy

Harris Company must set its investment and dividend policies for the coming year. It has three independent projects from which to choose, each of which requires a $6 million investment. These projects have different levels of risk, and therefore different costs of capital. Their projected IRRs and costs of capital are as follows:

Project A:	Cost of capital = 17%; IRR =	16%
Project B:	Cost of capital = 12%; IRR =	10%
Project C:	Cost of capital = 6%;  IRR =	9%

Harris intends to maintain its 50% debt and 50% common equity capital structure, and its net income is expected to be $7,012,000. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be? Round your answer to two decimal places.

Answer 1

Answer :- Dividend Payout Ratio = 57.22%

Calculation :-

We select Project that have IRR > Cost of capital. In our Case Project C satifies this. so we take Project C.

Total capital required = 6,000,000

Investment = $6,000,000

debt weight = 50%

equity weight = 50%

Net income = $7,012,000

Dividend = Net income - (Investment * equity weight)

Dividend = 7,012,000 - (6,000,000 * 50%)

Dividend = 7,012,000 - 3,000,000

Dividend = $4,012,000

Dividend payout ratio = Dividend / Net income

= 4,012,000 / 7,012,000

= 0.5722 or 57.22%