Question

The capital budget of Creative Ventures Inc. is $1,000,000. The company wants to maintain a target capital structure that is 30% debt and 70% equity. The company forecasts that its net income this year will be $800,000. If the company follows a residual dividend policy, what will be its total dividend payment?

Answer 1

Calculate the total equity value as follows:

Equity value \(=\) Total capital \(\times\) Propotion of equity

$$ \begin{aligned} &=\$ 1,000,000 \times 70 \% \\ &=\$ 700,000 \end{aligned} $$

Calculate the total dividend as follows:

$$ \begin{aligned} \text { Total dividend } &=\text { Net income-Equity } \\ &=\$ 800,000-\$ 700,000 \\ &=\$ 100,000 \end{aligned} $$

Therefore, the total dividend payment is \(\$ 100,000\).

Note:

In case of residual dividend Policy Company pays as dividend from net income only after deducting equity investment.