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 $9,802,000. If Welch establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to two decimal places.

%

Project H (High risk): Cost of capital = 16% IRR = 22% Project M (Medium risk): Cost of capital = 14% IRR = 12% Project L (Low risk): Cost of capital = 8% IRR = 11%

Explanation / Answer

Fund needed in equity = $ 4 Million*3* 45% = 5.4 Million

Net Income = 9802000

Dividend Payout = 9802000-5400000 = 4402000

Payout Ratio = 4402000/9802000 = 0.4491 or 44.91%

Answer: 44.91%

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