Gaven Industries is expected to generate $1,200,000 in net income over the next
ID: 2646945 • Letter: G
Question
Gaven Industries is expected to generate $1,200,000 in net income over the next year. Gaven has forecasted a capital budget of $1,200,000 and it wishes to maintain its current capital structure of 60% debt and 40% equity. If the company follows a strict residual dividend policy, what l its expected dividend payout ratio for this year? Gayen Industries has very stable, predictable earnings, but its capital investment tends to be lumpy. That means that its required capital budget usually is relatively low, but every few years some large expenditures cause the firm?s capital budget to be quite large. Should Gaven be following a strict residual dividend policy?Explanation / Answer
3. a) Capital budget = $1,200,000
Equity % = 40
Equity investment required for capital structure = Capital budget x Equity%
= 1200000 x 0.40
= $480,000
Money available for dividend out of net income = Net income - Equity investment
= 1,200,000 - 480,000
= $720,000
Which means company can pay 60% of its net income.
Expected dividend payout ratio = 60%
b) No. because in case of large expenditure company will not be able to follow the capital structure.
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