Question

Grandin Inc. is evaluating its dividend policy. It has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio?

Answer 1

Based on residual dividend policy, the dividend payments are made from the equity that remains after all the project capital needs are met.

For this question,

Capital Budget = $675,000

40% of this comes from equity to maintain the capital structure.

40% of this capital budget = 40% * $675,000 = $250,000

Residual dividend = Net Income - Amount required for capital budget

Residual dividend = $475,000 - $250,000 = $225,000

Dividend payout ratio = $225,000/$475,000 = 47.37%