Dentaltech Inc. projects the following data for the coming year. If the firm follows the residual dividend policy and also maintains its target capital structure, what will its payout ratio be?

Question

Quizplus · Accepted Answer

The residual dividend policy involves paying out dividends only after financing all profitable projects and maintaining the target capital structure. To calculate the payout ratio, we need to first calculate the total dividends paid out from the residual profits, which is the difference between the net income and the amount needed to maintain the target capital structure.

Total dividends = Net income - (Target capital structure x Total assets)
Total dividends = $3,550,000 - ($3,500,000/$10,000,000 x $25,000,000)
Total dividends = $3,550,000 - $8,750,000
Total dividends = -$5,200,000 (negative means the firm does not have enough residual profits to pay dividends)

Since the firm does not have enough residual profits to pay dividends, the payout ratio will be 0%.

Therefore, the best choice is:

Answer: D