Final answer:
Peterson & Peterson Company will have a dividend per share of $2, a dividend payout ratio of 33.33%, and will need $4 million of equity financing and $6 million of long-term debt for their project. The residual policy has benefits like efficient capital use but also drawbacks like high dividend payment variability.
Step-by-step explanation:
The Peterson & Peterson Company is planning a capital expansion project next year that will require a $10 million investment. The company's target capital structure is 60% debt and 40% equity. With a net income of $6 million and 1 million shares outstanding, under a residual distribution policy, the company will use the net income first for investment and the remainder for dividends.
First, to determine the amount needed for equity financing:
Equity requirement = 40% of $10 million = $4 million.
Since the net income is $6 million, the entire equity portion can be financed through net income, and there will be a surplus of $2 million ($6 million - $4 million).
Thus, the total dividends paid will be $2 million, which gives us a dividend per share of:
Dividend per share = $2 million / 1 million shares = $2 per share.
The dividend payout ratio is the ratio of total dividends to the net income:
Dividend payout ratio = $2 million / $6 million = 33.33%.
The amount of long-term debt needed is 60% of $10 million, which equals $6 million.
Advantages of Peterson's residual policy include aligning dividend payments with surplus earnings, which promotes efficient capital use. Disadvantages include potentially high variability in dividend payments, impacting signaling to investors and potentially affecting the clientele who prefer stable dividends.