Question

ABC, Inc. has 25,000 shares of stock outstanding at a market price of $20. The firm has $500,000 in outstanding debt. Earnings for next year are projected at $100,000. The firm plans on spending $120,000 on capital projects next. The firm also maintains a constant debt-equity ratio. What is the projected dividend amount per share if the firm follows a residual dividend policy?

A $ 20

B $ 0

c $60

D $1.20

E $1.60

Answer 1

No of shares	25,000
Share price	$           20.00
Total equity value	25000*20
Total equity value	$      500,000
Outstanding debt	$      500,000
Total value	$   1,000,000
Debt %age	50%
New capital investment next year	$      120,000
Same debt ratio will be maintained so financed through debt-50%	$         60,000
Financed through retained earnings	$         60,000
Next year profit	$      100,000
Used for capital investment	$       (60,000)
Dividend distribution	$         40,000
No of shares	25,000
Dividend per share	40000/25000
Dividend per share	$             1.60
Hence option E is the correct answer.