Question

Harris Company must set its investment and dividend policies for the coming year. It has three independent projects from which to choose, each of which requires a $3 million investment. These projects have different levels of risk, and therefore different costs of capital. Their projected IRRs and costs of capital are as follows: Project A: Cost of capital = 18%; IRR = 21% Project B: Cost of capital = 14%; IRR = 11% Project C: Cost of capital = 7%; IRR = 10% Harris intends to maintain its 35% debt and 65% common equity capital structure, and its net income is expected to be $6,288,000. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be? Round your answer to two decimal places. %

Answer 1

Dividend payout ratio = 37.98%

Step-by-step explanation:

Residual dividend policy means where a company uses residual equity to fund dividend payments.

We will accept Project A & C because Project B has lesser IRR than its Cost of Capital

Total investment = $3,000,000 * 2

Total investment = $6,000,000

Dividends = Earnings - Investment

Dividends = $6,288,000 - 65%*($6,000,000)

Dividends = $6,288,000 - 0.65($6,000,000)

Dividends = $6,288,000 - $3,900,000

Dividends = $2,388,000

Dividend payout ratio = Dividend / Total earnings

Dividend payout ratio = $2,388,000 / $6,288,000

Dividend payout ratio = 0.379771

Dividend payout ratio = 37.98%