Question

Puckett products is planning for $5 million in capital expenditures next year. puckett’s target capital structure consists of 60% debt and 40% equity. if net income next year is $3 million and puckett follows a residual distribution policy with all distributions as dividends, what will be its dividend payout ratio

Answer 1

To find out the payout, we must first figure out the amount of equity we are retaining for capital budget and then subtract from our Net Income. This calculation will give us the amount in which will be paid out and we can then divide this remaining amount by our Net Income to find the payout ratio.

 

Distribution = Net Income - (Target Equity Ratio * Target Capital Budget)

Net Income$3,000,000

Target Capital Budget$5,000,000

Target Equity Ratio 40%

Distribution =$1,000,000

Knowing our distribution is $1,000,000, we can divide the distribution by Net Income to find the payout ratio.

 

Distribution$1,000,000

Net Income$3,000,000

Payout Ratio 33.33% or 1:3