Question

Purple Hedgehog Forestry Inc. is expected to generate $200,000,000 in net income over the next year. Purple Hedgehog Forestry has forecasted a capital budget of $85,000,000, and it wishes to maintain its current capital structure of 70% debt and 30% equity.

Required:
What will Purple Hedgehog Forestry's dividend payout ratio be if it follows a residual dividend policy?

Answer 1

87.25%

Explanation:l

Capital Budget = $85,000,000

Financed through Equity = $25,500,000 (30%*$85,000,000)

Residual Earnings = Expected net income - Financed through Equity

Residual Earnings = $200,000,000 - $25,500,000

Residual Earnings = $174,500,000

Dividend Payout Ratio = Residual Earnings / Expected net income

Dividend Payout Ratio = $174,500,000 / $200,000,000

Dividend Payout Ratio = 0.8725

Dividend Payout Ratio = 87.25%