Question

Express Industry’s expected net income for next year is $1.6 million. Its target, and current, capital structure is 30 percent debt and 70 percent common equity. The director of capital budgeting has determined that the optimal capital budget for next years is $2 million. Suppose Express uses the residual dividend policy to determine next year’s dividend.

1. What is the expected dividend payout ratio?
2. Can we use the residual dividend policy to set dividends on an annual basis? Explain why.

Answer 1

Budget for next year = 2 million

Equity = 70% * 2000,000 = 1400,000

Net Income = 1,600,000 - 1400,000 = 2000,000

Dividend Payout ratio = 2000,000 / 1600,000 = 12.5%

NO, Residual Method can be used as we can see above that the residual Income is distributable amount but If there are capital exenditure in some years, the dividend may be decided but it will vary every year. so annual dividend can not be decided by Residual income Method.

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