McCann Publishing has a target capital structure of 35% debt and 65% equity.This year's capital budget is $850,000 and it wants to pay a dividend of $400,000.If the company follows a residual dividend policy, how much net income must it earn to meet its capital budgeting requirements and pay the dividend, all while keeping its capital structure in balance?
A) $904,875
B) $952,500
C) $1,000,125
D) $1,050,131
E) $1,102,638

Question

Quizplus · Accepted Answer

The amount of funds available for dividends and capital expenditures is calculated as:

Funds Available = Net Income - (1 - Target Dividend Payout Ratio) x Capital Expenditures

Assuming a target dividend payout ratio of 60% (since the dividend is $400,000 and the total funds available are $1,000,000), we can solve for the required net income:

$850,000 + $400,000 = Net Income - (1 - 0.6) x $850,000
$1,250,000 = Net Income - 0.4 x $850,000
$1,250,000 = Net Income - $340,000
Net Income = $1,590,000

So the company must earn $1,590,000 in net income to meet its capital budgeting requirements and pay the dividend, while keeping its capital structure in balance.

McCann Publishing Has a Target Capital Structure of 35% Debt