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Hermes Co. has a capital budget of $1,200,000


Hermes Co. has a capital budget of $1,200,000. The company wants to maintain a target capital structure which is 60 percent debt and 40 percent equity. The company forecasts that its net income this year will be $600,000. If the company follows a residual dividend policy, what will be its payout ratio? 


40% 20% 100% 60% 80%

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Answer #1

ANSWER = 20%

According to Residual Dividend Policy,

DIVIDEND = NET INCOME - (TARGETED EQUITY RATIO X TOTAL CAPITAL BUDGET)

Dividend = $600,000 - (40% X $1,200,000)

Dividend = $600,000 - $480,000

Dividend = $120,000

Payout ratio = Dividend / Net income

Payout ratio = 120,000 / 600,000

Payout ratio = 0.2 or 20%

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