Drop down options for 1: 315 million, 270 million, 300 million, 255 million Drop

Question

Drop down options for 1:

315 million, 270 million, 300 million, 255 million

Drop down options for 2:

decrease, increase

Drop down options for 3:

should, should not

16. The residual dividend model The residual dividend policy approach is based on the theory that a firm's optimal distribution policy is a function of the firm's target capital structure, the investment opportunities that the firm has, and the availability and cost of external capital. The firm makes distributions based on the residual earnings. Consider the following example: Blime Inc. is expected to generate $200 million in net income over the next year. Blime Inc.'s stockholders expect it to maintain its long-run dividend payout ratio of 40% of earnings 40% Equity 60% Debt If the firm wants to maintain its current capital structure of 60% debt and 40% equity, what is the maximum capital budget it can support with this year's expected net income? | If Blime Inc. increases its debt ratio, its dividend payout ratio will held constant. , assuming that all other factors are Allied Biscuit Co. has very stable, predictable earnings, but its capital investment tends to be lumpy. That means that its required capital budget usually is relatively low, but every few years some large expenditures cause the firm's capital budget to be quite large. Allied Biscuit Co. FaceTime pllow a strict residual dividend policy

Explanation / Answer

Solution for question 1

Net Income = $200 million

Payout ratio = 40%

Total Dividend = 40% × $200 million

                         = $80 million

Total Net income transferred to retained earning = $200 million - $80 million

                                                                              = $120 million

So because of retained earning value of equity increase by $120 million and debt equity ratio of company is 40% equity and 60% debt.

So, Maximum capital Budget to maintain current debt equity ratio is calculated below:

Capital budget = $120 million / 40%

                        = $300 million

Maximum capital Budget to maintain current debt equity ratio is $300 million.

Solution for question 2

If company increase its debt ratio then return on equity increase because of tax shield gain of interest payment. In this case dividend of company will increase.

Solution for question 3

Residual dividend policy mean pay all the income after paying all the obligation to the equity holder. So retained earning of company is zero. Usually company invest in large capital budget in every few year.

So company should not pay residual dividend.

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