3. Residual dividend model - Dividends paid Gaven Industries is expected to gene

Question

3. Residual dividend model - Dividends paid Gaven Industries is expected to generate $800,000 In net income over the next year. Gaven has forecasted a capital budget of $1,000,000 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 is its expected dividend payout ratio for this year? 40% 70% 60% 10% 50% Gaven 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? yes No

Explanation / Answer

Capital budget = 1000000

Amount required to be financed by equity = 1000000*0.40 i.e 400000

Net Income = 400000

Dividend to be distributed = 800000-400000 i.e 400000

Dividend payout ratio = 400000/800000 i.e 50%

B) Yes , it should be following residual policy as it protects the company from getting its resources financed from external soiurces

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