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 $4 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 =	15%;		IRR =	16%
Project B:	Cost of capital =	13%;		IRR =	11%
Project C:	Cost of capital =	8%;		IRR =	10%

Harris intends to maintain its 45% debt and 55% common equity capital structure, and its net income is expected to be $11,750,000. 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

Solution for Harris Company.>

A residual dividend policy is one where a company uses residual or leftover equity to fund dividend payments.

We will accept projects A and C because their IRR > cost of capital.

Total Investment = $4 million * 2 = $8 million

Dividend = Earnings - Investment in equity

= $11,750,000 - 55%* $8 million

= $11,750,000 -$4,400,000

= $7,350,000

Dividend Payout ratio = Dividend/ Total Earnings

= $7,350,000/$11,750,000

= 62.55%

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