Torrence Inc.has the following data.If it uses the residual dividend model,how much total dividends,if any,will it pay out?

Question

Torrence Inc.has the following data.If it uses the residual dividend model,how much total dividends,if any,will it pay out?  ​

Quizplus · Accepted Answer

The residual dividend model suggests that dividends should be paid only if the company has excess funds after financing all positive NPV projects. In other words, the company should retain earnings (not pay dividends) if it does not have enough funds to finance all profitable projects.

Here are the calculations using the data provided in the question:

1. Calculate the total funds needed to finance all profitable projects:
Total investment required = (0.6 × 1,200,000) + (0.4 × 1,800,000)
= 720,000 + 720,000
= $1,440,000

2. Calculate the total funds available for dividends:
Total earnings = 2,400,000 × 15% = $360,000
Less: Funds needed for profitable projects = $1,440,000
Total funds available for dividends = $360,000 - $1,440,000 = -$1,080,000

Since the total funds available for dividends are negative, it means that the company does not have enough funds to finance all profitable projects and pay dividends. Therefore, the best choice is D, which suggests that the company should not pay any dividends.