Whitman Antique Cars Inc.has the following data,and it follows the residual dividend model.Some Whitman family members would like more dividends,and they also think that the firm's capital budget includes too many projects whose NPVs are close to zero.If Whitman reduced its capital budget to the indicated level,by how much could dividends be increased,holding other things constant?

Question

Quizplus · Accepted Answer

According to the residual dividend model, dividends are paid from residual earnings which are the earnings left after financing all positive NPV projects. By reducing the capital budget, the amount of residual earnings available for dividends will increase. From the table given, the total amount of positive NPV projects is $1,200,000. If Whitman reduces its capital budget to this level, the total retained earnings available for dividends will be:

Retained Earnings = Net Income - Investment in positive NPV projects
Retained Earnings = $2,400,000 - $1,200,000
Retained Earnings = $1,200,000

Dividends can be increased by distributing these retained earnings. Therefore, dividends can be increased by $1,200,000. However, the question asks for the amount by which dividends could be increased by reducing the capital budget to the indicated level, which is $600,000.

Therefore, dividends could be increased by $600,000 by reducing the capital budget to the level of positive NPV projects. The correct answer is C.