Residual dividend model- Axel Telecommunications has a target capital structure

Question

Residual dividend model- Axel Telecommunications has a target capital structure that consists of 60% debt and 40% equity. The company anticipates that its capital budget for the upcoming year will be $1,000,000. If Axel reports net income of $1,200,000 and it follows a residual dividend payout policy, what will be its dividend payout ratio? Round your answer to two decimal places. ___________% .......................................... STOCK SPLIT- Gamma Medical's stock trades at $80 a share. The company is contemplating a 3-for-1 stock split. Assuming that the stock split will have no effect on the market value of its equity, what will be the company's stock price following the stock split? Round your answer to the nearest cent. $ ____________

Explanation / Answer

GIVEN THE OPTIMAL CAPITAL BUDGET AND THE TARGET CAPITAL STRUCTURE, WE MUST NOW DETERMINE THE AMOUNT OF EQUITY NEEDED TO FINANCE THE PROJECTS. OF THE $1,000,000 REQUIRED FOR THE CAPITAL BUDGET, 0.4($1,000,000) = $4,00,000 MUST BE RAISED AS EQUITY AND 0.6($1000,000)= $600,000 MUST BE RAISED AS DEBT IF WE ARE TO MAINTAIN THE OPTIMAL CAPITAL STRUCTURE: DEBT $400,000 40% EQUITY $600,000 60% --------------------------- $1,000,000 100% (when following residual dividend policy) IF A RESIDUAL EXISTS-- THAT IS, IF NET INCOME EXCEEDS THE AMOUNT OF EQUITY THE COMPANY NEEDS-- THEN IT SHOULD PAY THE RESIDUAL AMOUNT OUT IN DIVIDENDS. SINCE $12,00,000 OF EARNINGS IS AVAILABLE, AND ONLY $400,000 IS NEEDED for equity, THE RESIDUAL IS $12,00,000 - $400,000 = $800,000. SO THIS IS THE AMOUNT THAT SHOULD BE PAID OUT AS DIVIDENDS. THUS,THE PAYOUT RATIO WOULD BE $800,000/$12,00,000 = 0.67(rounded to 2 decimals) = 67%. b) given Market price = $80 and it is not affected by stock split. given that company is contemplating 3-for-1 stock split i.e., for 1 every one share should be splitted into 3 shares. Hence the value of each stock/share after stock split = $80/3 = $26.67 (rounded to nearest cent)

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