A firm projects next year's after-tax earnings at $300,000 and proposes capital budgeting expenditures of $300,000 for new projects. If the target capital structure is 30% debt and 70% equity, what should the dividend payout ratio be if the firm adheres strictly to the residual dividend theory?

Question

Quizplus · Accepted Answer

The residual dividend theory states that dividends should be paid out of the earnings that are left over after all capital budgeting expenditures have been made. In this case, the firm has projected after-tax earnings of $300,000 and capital budgeting expenditures of $300,000. Therefore, the firm will have no earnings left over to pay dividends, and the dividend payout ratio should be 0%.

A Firm Projects Next Year's After-Tax Earnings at $300,000 and Proposes