Question

Whitman Antique Cars Inc. has the following data, and it follows the residual dividend model. Some Whitman family members would like more dividends, and they also think that the firm's capital budget includes too many projects whose NPVs are close to zero. If Whitman reduced its capital budget to the indicated level, by how much could dividends be increased, holding other things constant?Original capital budget $3,000,000New capital budget $2,150,000Net income $3,500,000% Debt 35%a. $484,100b. $493,500c. $404,200 d. $521,700 e. $470,000

Answer 1

Answer:

Dividends would increase by $552500.

Explanation:

Original capital budget         $3,000,000

New capital budget              $2,150,000

Net income                            $3,500,000

% Debt                                          35%

                                                         Old                    New

% Debt                                                   35%                 35%

% Equity = 1 – %Debt                            65%                 65%

Capital budget                              $3,000,000            $2,150,000

Net income (NI)                         $3,500,000              $3,500,000

Equity needed to support

the capital budget =

%Equity * Capital budget               $1,950,000               $1,397,500

Dividends paid =                            $1,550,000               $2,102,500

NI - Equity needed

if positive.

Increase in dividends paid = $2,102,500 - $1,550,000 = $552500.