Flavortech Inc.expects EBIT of R2,000,000 for the coming year.The firm's capital structure consists of 40 percent debt and 60 percent equity, and its marginal tax rate is 40 percent.The cost of equity is 14 percent, and the company pays a 10 percent rate on its R5,000,000 of long-term debt.One million ordinary shares are outstanding.In its next capital budgeting cycle, the firm expects to fund one large positive NPV project costing R1,200,000, and it will fund this project in accordance with its target capital structure.If the firm follows a residual dividend policy and has no other projects, what is its expected dividend payout ratio?

Question

Quizplus · Accepted Answer

The firm will fund the R1,200,000 project with 40% debt and 60% equity, meaning R720,000 will be funded with equity. The residual dividend policy means dividends are paid from leftover earnings after funding projects. EBIT is R2,000,000, and after 40% tax, net income is R1,200,000. After funding the project with R720,000 from equity, R480,000 remains for dividends. The payout ratio is R480,000/R1,200,000 = 40%.