Driver Corporation has plans calling for a capital budget of $60 million. Its optimal capital structure is 60 percent equity and 40 percent debt. Its earnings before interest and taxes (EBIT) were $98 million for the year. The firm has $200 million in assets, pays an average of 10 percent on all its debt, and faces a marginal tax rate of 35 percent. If the firm maintains a residual distribution policy (with all distributions in the form of dividends) and will keep its optimal capital structure intact, what will be the amount of the dividends it pays out after financing its capital budget?
A) $22.5 million
B) $59.4 million
C) $60.0 million
D) $30.0 million
E) $ 0

Question

Quizplus · Accepted Answer

The firm needs to finance 60% of its $60 million capital budget with equity, which is $36 million. The residual earnings after financing the capital budget will be paid as dividends. EBIT is $98 million, interest is 10% of $80 million (40% of $200 million), which is $8 million. Taxable income is $90 million, and after-tax income is $58.5 million. After financing $36 million from equity, $22.5 million remains for dividends.

Driver Corporation Has Plans Calling for a Capital Budget of $60