Question

Harris Company must set its investment and dividend policies for the coming year. It has three independent projects from which to choose, each of which requires a $5 million investment. These projects have different levels of risk, and therefore different costs of capital. Their projected IRRs and costs of capital are as follows: Project A: Cost of capital = 15%; IRR = 18% Project B: Cost of capital = 14%; IRR = 9% Project C: Cost of capital = 7%; IRR = 8% Harris intends to maintain its 25% debt and 75% common equity capital structure, and its net income is expected to be $9,476,000. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be? Round your answer to two decimal places.

Answer 1

Answer :- Dividend Payout Ratio = 20.85%

Calculation :-

We select Project that have IRR > Cost of capital. In our Case Project A & C satifies this. so we take these 2 projects.

Total capital required = 5,000,000 * 2 ==> 10,000,000

Investment = $10,000,000

debt weight = 25%

equity weight = 75%

Net income = $9,476,000

Dividend = Net income - (Investment * equity weight)

Dividend = 9,476,000 - (10,000,000 * 75%)

Dividend = 9,476,000 - 7,500,000

Dividend = $1,976,000

Dividend payout ratio = Dividend / Net income

= 1,976,000 / 9,476,000

= 0.2085 or 20.85%