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Suppose a company has $900 million in planned capital spending (representing positive NPV projects). The company’s...

  1. Suppose a company has $900 million in planned capital spending (representing positive NPV projects). The company’s target capital structure is 60% debt and 40% equity. Given that the company follows a residual dividend policy and has earnings of $500 million, what is the company’s expected dividend?
  2. If the company in a) has a fixed payout ratio of 40% instead, what is the company’s expected dividend? How much external financing would be required?
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Answer #1

a.capital Spending = $900 million

To be financed through equity = 40% i.e $360 million

Under residual dividend policy, earnings remaining after meeting requirements of all upcoming projects is distributed

Earnings = $500 million

Required by Capital Project = $360 million

Expected dividend = $140 million

b.Payout ratio = 40%

Expected Dividend = 500 million*40% = $200 million

Funds available internally = $300 million

External financing required = 360 million – 300 million = $60 million from equity

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