In year 0 a firm paid dividends of $5 million. They have a target payout ratio of .6, and their earnings in Year 1 are $15 million. If their alpha or speed of adjustment is .4, their dividends for Year 1 would be

Question

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The firm's target dividends for Year 1 based on a payout ratio of .6 would be 0.6 * $15 million = $9 million. The adjustment factor (alpha) of .4 applied to the difference between target dividends and last year's dividends ($9 million - $5 million = $4 million) gives an adjustment of .4 * $4 million = $1.6 million. Therefore, the dividends for Year 1 would be last year's dividends plus the adjustment, or $5 million + $1.6 million = $6.6 million.

In Year 0 a Firm Paid Dividends of $5 Million