Pavlin Corp.'s projected capital budget is $2,000,000, its target capital structure is 40% debt and 60% equity, and its forecasted net income is $1,000,000. If the company follows a residual dividend policy, how much dividends will it pay or, alternatively, how much new stock must it issue?

Question

Quizplus · Accepted Answer

Under a residual dividend policy, dividends are paid only after all profitable investment opportunities are funded. Pavlin Corp. needs $1,200,000 in equity (60% of $2,000,000). With $1,000,000 in net income, it needs an additional $200,000, so it will issue $200,000 in new stock and pay $0 in dividends.