D.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 model,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 model states that the dividend is paid out of the income that is left after all other expenses and investments have been paid. In this case, the company has a capital budget of $725,000, and it wants to maintain a target capital structure of 45% debt and 55% equity. This means that the company will need to borrow $326,250 (45% of $725,000) and issue $398,750 (55% of $725,000) in new equity. The company also wants to pay a dividend of $500,000. This means that the company will need to earn $898,750 (326,250 + 398,750 + 500,000) in order to meet its financial obligations. The dividend payout ratio will be 55.63% (500,000 / 898,750).

DPaul IncForecasts a Capital Budget of $725,000