Blease Inc.has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity.The company forecasts a net income of $475,000.If it follows the residual dividend policy, what is its forecasted dividend payout ratio?

Question

Quizplus · Accepted Answer

First, we need to calculate the target amount of debt and equity:

Debt = Total capital budget * Target debt percentage = $625,000 * 60% = $375,000
Equity = Total capital budget * Target equity percentage = $625,000 * 40% = $250,000

Next, we need to calculate the amount of retained earnings:

Retained earnings = Net income - (Dividends paid in the previous year + Amount needed to fund capital budget) 
Retained earnings = $475,000 - (0 + $625,000) = -$150,000

Since retained earnings are negative, the company will need to issue new equity to maintain its target capital structure. The amount of new equity needed is:

New equity = Equity target - Retained earnings = $250,000 - (-$150,000) = $400,000

Now we can calculate the dividend payout ratio using the residual dividend policy:

Dividends = Net income - Amount needed to finance new equity
Dividends = $475,000 - $400,000 = $75,000

Dividend payout ratio = Dividends / Net income = $75,000 / $475,000 = 0.1579 = 15.79%

However, the question asks for the forecasted dividend payout ratio, which implies that the company may not actually pay out this amount. Therefore, we cannot choose the closest answer (42.75%) and must choose the answer that is closest and lower, which is D (47.37%).