Question

Residual Dividend Policy Example

GIVEN:
a-Need $5 million for new investments
b-Target capital structure: D/E=2/3 (2 portions financed with debt, 3 portions financed with equity)
c-Net Income = $4 million

Answer 1

The firm would not pay any dividends due to a net loss.

Step-by-step explanation:

In this scenario, the firm needs $5 million for new investments and has a target capital structure of debt-to-equity ratio of 2/3. The net income of the firm is $4 million. A residual dividend policy can be applied in this case. Under this policy, the firm first meets its capital budgeting needs, which is the investment of $5 million. The remaining profits, $4 million - $5 million = -$1 million, would be paid out as dividends. However, since the firm has a net loss, no dividends would be paid out.