Blease Inc. has a capital budget of $625,000, and it wants to maintain a target capital structure...

Question:

Blease Inc. has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts a net income of $475,000.

If it follows the residual dividend policy, what is its forecasted dividend payout ratio?

Dividends:

The investor purchases the stock to make money on two counts, first, the dividends declared and paid by the company and capital appreciation (market rate is more than the purchase price of the stock). The company distributes the net income generated by the company to the shareholders by way of dividend, and the percentage of dividend payout depends upon company's policy

Answer and Explanation:

The information required to calculate the dividend to be paid in the residual dividend model

  • The capital budget/investment is $625,000
  • The net income is $475,000
  • The equity ratio is 40%

Dividend to be paid = Net Income - (Desired equity ratio x capital budget)
=$475,000 - (40% x $625,000)
=$475,000 - $250,000
=$225,000

The dividend to be paid in the residual dividend model is $225,000

Dividend payout ratio = Dividend paid / Net Income
=225,000 / 475,000
=0.47368 or 47.37%

The forecasted dividend payout ratio is 47.37% as per residual dividend policy


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Dividend: Definition & Overview

from GMAT Prep: Tutoring Solution

Chapter 1 / Lesson 8
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