FOR A) They want us to use the formula
Dividends = Retained Earnings - ( capital expenditure * target equity weight)
but when I do 2,000,000- (2,000,000 * .4) i get 1200000 and they say the answer is 800,000
are they wrong?
ANSWER
FORMULA used is Correct BUT you are using WRONG VALUES
Under Resudual Dividend Policy, first we pay dividend only from left over earnings.
So from the Retained Earnings we have to Reduce that much Amount of Capital Expenditure that would be borne by Equity holders. So we have to MULTIPLY BY EQUITY RATIO and NOT DEBT RATIO
a) 1st part
DIVIDEND AMOUNT = Retained Earnings - Amount of Capital Exp that will be Borne by Equity
= Retained Earnings - (Capital Exp * Equity Weight)
= 2000000 - { 2000000 * (1-0.4) }
=2000000 - { 2000000 * 0.6 }
= 2000000 - 1200000
= 800000
a) 2nd part
Dividend Payout Ratio = { Dividend Amount / Retained Earnings } * 100
= { 800000 / 2000000 } * 100
= 40 %
a) 3rd part
DIVIDEND AMOUNT = Retained Earnings - Amount of Capital Exp that will be Borne by Equity
= Retained Earnings - (Capital Exp * Equity Weight)
= 2000000 - { 3000000 * (1-0.4) }
=2000000 - { 3000000 * 0.6 }
= 2000000 - 1800000
= 200000
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