the dividend Residual dividend policy As president of Young\'s of California, a

Question

the dividend Residual dividend policy As president of Young's of California, a large clothing chain, you have just received a letter from a major stockholder. The stockholder asks about the company's dividend policy. In fact, the stockholder has asked you to estimate the amount of the dividend that you are likely to pay next year. You have not yet collected all the information about the expected dividend payment, but you do know the following 2 P14- (1) The company follows a residual dividend policy. (2) The total capital budget for next year is likely to be one of three amounts, depending on the results of capital budgeting studies that are currently un- der way. The capital expenditure amounts are $2 million, $3 million, and $4 million. Theten ris$2million. (4) The target or optimal capital structure is a debt ratio of 40%. You have decided to respond by sending the stockholder the best information avail- able to you. a. Describe a residual dividend policy.

Explanation / Answer

Residual income refers to free profits available to equity shareholders after providing for all the expenses, interest on debt and preference divident to preferred stock holders. This is the amount which is exclusivly reserved for equity shareholders only. capital expenditure required 2 3 4 debt 0.8 1.2 1.6 retained earning to be used 1.2 1.8 2 retained earning left 0.8 0.2 0 common stock to be issued 0 0 0.4 dividend pay out ratio 0.4 0.1 0 In this case company will pay dividend of 40% because after meeting the amount of required capital expenditure company will distribute remaining retained earning amount as dividend to the shareholders In this case company will pay dividend of 10% because after meeting the amount of required capital expenditure company will distribute remaining retained earning amount as dividend to the shareholders there is no retained earnings left so company will need to issue additional equity share to meet out the required capital expenditure

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