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Dividend Policy Tutorial and Solutions

The document provides a tutorial on dividend policy with examples from different companies, illustrating how to calculate total dividend payments and required net income under a residual dividend policy. It includes calculations for capital budgets, target capital structures, and payout ratios for P&D Co., Ting Technology, Paul Inc., Keys Financial, and Dentaltech Inc. The examples demonstrate the relationship between net income, dividends, and capital structure maintenance.

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126 views2 pages

Dividend Policy Tutorial and Solutions

The document provides a tutorial on dividend policy with examples from different companies, illustrating how to calculate total dividend payments and required net income under a residual dividend policy. It includes calculations for capital budgets, target capital structures, and payout ratios for P&D Co., Ting Technology, Paul Inc., Keys Financial, and Dentaltech Inc. The examples demonstrate the relationship between net income, dividends, and capital structure maintenance.

Uploaded by

gajendra.naidu
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Dividend Policy Tutorial and Solutions

1. P&D Co. has a capital budget of $1,000,000. The company wants to


maintain a target capital structure which is 30% debt and 70% equity. The
company forecasts that its net income this year will be $800,000. If the
company follows a residual dividend policy, what will be its total dividend
payment?

Answer:

The amount of new investment which must be financed with equity is:
$1,000,000  70% = $700,000.
Since the firm has $800,000 of net income only $100,000 will be left for
dividends.

2. Ting Technology has a capital budget of $850,000, it wants to maintain a


target capital structure of 35% debt and 65% equity, and it also wants to
pay a dividend of $400,000. If the company follows a residual dividend
policy, how much net income must it earn to meet its capital budgeting
requirements and pay the dividend, all while keeping its capital structure in
balance?
Answer:

Capital budget $850,000


Equity ratio 65%
Dividends to be paid $400,000
Required net income = Dividends + (Capital budget  % Equity) $952,500

3. Paul Inc. forecasts a capital budget of $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 $500,000. If the company follows the residual
dividend policy, how much income must it earn, and what will its dividend
payout ratio be?

Answer:

Capital budget $725,000


Equity ratio 55%
Dividends paid $500,000
NI=Divs + (Eq % × Cap Bud)$898,750
Payout = Dividends/NI 55.63%
4. Keys Financial has done extremely well in recent years, and its stock now
sells for $175 per share. Management wants to get the price down to a
more typical level, which it thinks is $25 per share. What stock split would
be required to get to this price, assuming the transaction has no effect on
the total market value? Put another way, how many new shares should be
given per one old share?

Answer: c

Current price $175.00


Target price $25.00
No. of new shares per 1 old share = Current price/Target price 7.00

5. Dentaltech Inc. projects the following data for the coming year. If the firm
follows the residual dividend policy and also maintains its target capital
structure, what will its payout ratio be?

EBIT $2,000,000 Capital budget $850,000


Interest rate 10% % Debt 40%
Debt outstanding $5,000,000 % Equity 60%
Shares outstanding $5,000,000 Tax rate 40%

Answer

EBIT $2,000,000 Capital budget $850,000


Interest rate 10% % Debt 40%
Debt outstanding$5,000,000 % Equity 60%
Shares outstanding$5,000,000 Tax rate 40%

EBIT $2,000,000
− Interest expense = interest rate × debt 500,000
Taxable income $1,500,000
− Taxes = Tax rate × income 600,000
Net income (NI) $900,000
− Equity needed for capital budget = % Equity(capital budget) =
510,000
Dividends = NI − Equity needed $390,000
Payout ratio = Dividends/NI 43.33%

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