Question

​(Residual dividend policy​) ​FarmCo, Inc. follows a policy of paying out cash dividends equal to the residual amount that remains after funding 20 percent of its planned capital expenditures. The firm tries to maintain a 20 percent debt and 80 percent equity capital structure and does not plan on issuing more stock in the coming year.​ FarmCo's CFO has estimated that the firm will earn $20 million in the current year.

a. If the firm maintains its target financing mix and does not issue any equity next​ year, what is the most it could spend on capital expenditures next year given its earnings​ estimate?

b. If​ FarmCo's capital budget for next year is $17 ​million, how much will the firm pay in dividends and what is the resulting dividend payout​ percentage?

Answer 1

Given,

Current earnings = $ 20 million

Solution :-

la it is mentioned that the earnings would be applied to 20% of its Capital expenditures. possible Total - Capital expenditure Current earnings 20% of 0.20 $20 million 0.20 - ¢ 100 million Capital budget = $ 17 million Retention against ratio this budget- = 20% Retained earnings a $ 17 million x 20% - $3.4 million

Dividends to and be paid = current earnings – Retained earnings of next year $ 20 million – $3.4 million - & 16.6 million Dividend payout percentage Dividends to be paid Current earnings - 0.83 of 83% $16.6 million $20 million