Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $500,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?

Question

Business

David Garza

3 July, 09:08

Paul Inc. forecasts a capital budget of $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $500,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?

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Celia · Answer 1

If the company follows the residual dividend policy, the income he must earn is $898,750

The dividend payout ratio will be 55.63%

Explanation:

In order to calculate the income must it earn we would have to make the following calculation:

income must it earn=55% equity+dividends

55% equity=$725,000*0.55

55% equity=$398,750

Therefore, income must it earn=$398,750+$500,000

income must it earn=$898,750

If the company follows the residual dividend policy, the income he must earn is $898,750.

To calculate the dividend payout ratio we would have to calculate the following formula:

dividend payout ratio=dividends paid/income must it earn

dividend payout ratio=$500,000 / $898,750

dividend payout ratio=55.63%

The dividend payout ratio will be 55.63%