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 $3 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 = 18%; IRR =	21%
Project B:	Cost of capital = 14%; IRR =	16%
Project C:	Cost of capital = 8%;  IRR =	6%

Harris intends to maintain its 30% debt and 70% common equity capital structure, and its net income is expected to be $8,943,500. 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

Expected Dividend Payout Ratio for this year

Total Dividend using the residual dividend policy

Total Dividend = Net Income – [Total Capital Budget x Equity Ratio]

= $8,943,500 [ $3,000,000 x 70%]

= $8,943,500 - $2,100,000

= $6,843,500

Expected Dividend Payout Ratio for this year

Therefore, the Expected Dividend Payout Ratio = [Total Dividend Paid / Net Income] x 100

= [$6,843,500 / $8,943,500] x 100

= 76.52%

“Hence, the Expected Dividend Payout Ratio would be 76.52%”