Question

The capital budget forecast for the Santano Company is $725,000. The CFO wants to maintain a target capital structure of 45% debt and 55% equity, and it also wants to pay dividends of $550,000. If the company follows the residual dividend policy, how much income must it earn, and what will its dividend payout ratio be?
Select the correct answer.

a. NI = $948,570

Payout = 57.93%
b. NI = $948,210

Payout = 57.85%
c. NI = $948,930

Payout = 58.01%
d. NI = $948,750

Payout = 57.97%
e. NI = $948,390

Payout = 57.89%

Answer 1

According to the residual dividend policy, the net income comes out to be $948,750 with a dividend payout ratio of 57.97%.

What is the net income?

Net income is the value that is determined by deducting the charges from the revenues and can be inferred from the profit or loss statement prepared by the company at the year-end.

Given values:

Capital budget: $725,000

Equity ratio: 55%

Dividends: $550,000

Step-1 Computation of net income as per residual dividend policy:

$\rm\ Net \rm\ Income=(\rm\ Capital \rm\ Budget \times\ \rm\ Equity \rm\ Ratio)+\rm\ Dividends\\\rm\ Net \rm\ Income=(\ 725,000\times\55\%)+\ 550,000\\\rm\ Net \rm\ Income=\ 398,750+\ 550,000\\\rm\ Net \rm\ Income=\ 948,750$

Step-2 Computation of dividend payout ratio:

$\rm\ Dividend \rm\ Payout \rm\ Ratio=\frac{\rm\ Dividends}{\rm\ Net \rm\ Income} \\\rm\ Dividend \rm\ Payout \rm\ Ratio=\frac{\ 550,000}{\ 948,750} \\\rm\ Dividend \rm\ Payout \rm\ Ratio=57.97\%$

Therefore, option D is the correct answer.

Learn more about the dividend payout ratio in the related link:

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