Portland Plastics Inc. has the following data. If it follows the residual dividend model, what is its forecasted dividend payout ratio?

Question

Quizplus · Accepted Answer

To calculate the forecasted dividend payout ratio using the residual dividend model, we need to first calculate the total equity of the company which is $93 million ($53 million common equity + $40 million retained earnings).

Next, we need to calculate the target equity balance, which is the equity balance required to maintain the company's target debt-to-equity ratio. The target debt-to-equity ratio is not given, so we cannot proceed with this step.

Finally, we can calculate the forecasted dividend payout ratio by using the formula: Dividend payout ratio = 1 - (Ending equity balance / Beginning equity balance). The beginning equity balance is $93 million (total equity) and the ending equity balance is not given. Therefore, we cannot calculate the dividend payout ratio.

However, if we assume that the target debt-to-equity ratio is not relevant and the company has no external financing needs, we can use the formula: Dividend payout ratio = 1 - (Change in retained earnings / Net income). 
The change in retained earnings is $10 million (ending retained earnings of $50 million - beginning retained earnings of $40 million). Net income is $45 million. 
Dividend payout ratio = 1 - (10/45) = 0.7778 or 77.78%. 
Therefore, the forecasted dividend payout ratio is 34.78% (100% - 77.78%). The answer is D.