Welch Company is considering three independent projects, each of which requires

Question

Welch Company is considering three independent projects, each of which requires a $4 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects is presented below: Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 60% debt and 40% common equity, and it expects to have net income of $10,124,500. If Welch establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to two decimal places.

Explanation / Answer

Total cost of project = 4 million +4 million + 4 million

                                        = 12 million

Amount financed through equity = 12 million x 60%

                                                                = 7.20 million

Dividend payout ratio = (Net Income – amount financed through equity)/ Net Income

                                           = (10,124,500 – 7,200,000)/ 10,124,500

                                           = 28.89%

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