Welch Company is considering three independent projects, each of which requires

Question

Welch Company is considering three independent projects, each of which requires a $4 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects is presented below:

Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 55% debt and 45% common equity, and it expects to have net income of $14,903,500. If Welch establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to two decimal places.

%

Please show calculation. Thanks!

Project H (High risk): Cost of capital = 15% IRR = 20% Project M (Medium risk): Cost of capital = 13% IRR = 13% Project L (Low risk): Cost of capital = 8% IRR = 12%

Explanation / Answer

Hi,

Please find the answer as follows:

Total Investment = 4000000 (since only 1 project will get accepted)

Dividend = Net Income - Total Investment*Equity Weight = 14903500 - 4000000*.45 =13103500

Dividend Payout Ratio = Dividend/Net Income = 13103500/14903500*100 = 87.92%

Answer is 87.92%

Thanks.

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