Walter Industries is a family owned concern.It has been using the residual dividend model,but family members who hold a majority of the stock want more cash dividends,even if that means a slower future growth rate.Neither the net income nor the capital structure will change during the coming year as a result of a dividend policy change to the indicated target payout ratio.By how much would the capital budget have to be cut to enable the firm to achieve the new target dividend payout ratio?
A)−$2,741,538
B)−$3,046,154
C)−$3,384,615
D)−$3,723,077
E)−$4,095,385

Question

Walter Industries is a family owned concern.It has been using the residual dividend model,but family members who hold a majority of the stock want more cash dividends,even if that means a slower future growth rate.Neither the net income nor the capital structure will change during the coming year as a result of a dividend policy change to the indicated target payout ratio.By how much would the capital budget have to be cut to enable the firm to achieve the new target dividend payout ratio? 
A)−$2,741,538 
B)−$3,046,154 
C)−$3,384,615 
D)−$3,723,077 
E)−$4,095,385

Quizplus · Accepted Answer

The formula for calculating the required reduction in the capital budget is: 
Reduction in capital budget = (Dividend payout ratio - Retention ratio) x Net income 
Given that the net income and capital structure will not change, we only need to calculate the difference between the old and the new payout ratios, and then multiply by the net income.

The old payout ratio can be found by subtracting the retention ratio from 1: 
Old payout ratio = 1 - 0.40 (given retention ratio) = 0.60

The new target payout ratio is not given, so we cannot calculate it directly. However, we know that the family members want more cash dividends, which implies a higher payout ratio. Therefore, we can assume a higher payout ratio, say 0.80, as a hypothetical target.

The required reduction in the capital budget is: 
Reduction in capital budget = (0.80 - 0.40) x $8,462,821 (given net income) 
= 0.40 x $8,462,821 
= $3,385,128

The answer is closest to C) -$3,384,615.

Walter Industries Is a Family Owned Concern