Residual Model, NI, Dividends, and Payouts a.) The capital budget forecast for t
ID: 2640671 • Letter: R
Question
Residual Model, NI, Dividends, and Payouts
a.) The capital budget forecast for the Santo Company is $800,000. The CFO wants to maintain a target capital structure of 40% debt and 60% equity, and it also wants to pay dividends of $500,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?
b.) United Builders wants to maintain a target capital structure with 30% debt and 70% equity. Its forecasted net income is $500,000, and because of market conditions, the company will not issue any new stock during the coming year. If the firm follows the residual dividend policy, what is the maximum capital budget that is consistent with maintaining the target capital structure?
c.) Brinkley Resources stock has increased signifigantly over the last five years, selling now for $180 per share. Management feels this price is too high for the average investor and wants to get the price down to a more typical evel, which it thinks is $30 per share. What stock split would be required to get this price, assuming the transaction has no effect on the total market value? Put another way, how many new shares should be given per one old share?
Explanation / Answer
a. Capital Requirement: $800,000
Debt Equity Ratio: 40% Debt, 60% Equity
Debt: $320,000, Equity: $480,000 (Value of internally Generated Equity)
Amount Required for Dividend: $500,000
Total Income must Earn = 500,000 + 480,000 = $980,000
Dividend Payout Ratio = 500,000 / 980,000 = 51%
B. Net Income Available: $500,000
Target Capital Structure: 30% Debt, 70% Equity
Maximum Capital Budget consistent with the Capital Structure = 500,000 / 70 x 100 = $714,286
C. Current Market Price = $180
Required Market Price = $30
So, Stock should be splited in: 180/30 = 6 Share
So, 6 new shares should be in place of every 1 Old Share.
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