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 she also wants to pay a dividend 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

Quizplus · Accepted Answer

The correct answer is A because the residual dividend policy states that the dividend is paid out of the residual income after all other financial obligations have been met. In this case, the company has a capital budget of $725,000 and wants to maintain a target capital structure of 45% debt and 55% equity. This means that the company will need to raise $326,250 in debt and $398,750 in equity. The company also wants to pay a dividend of $500,000. Therefore, the company must earn $898,750 in order to meet all of its financial obligations. The dividend payout ratio will be 55.63%.

Paul Inc Forecasts a Capital Budget of $725,000