Residual dividend model Welch Company is considering three independent projects,

Question

Residual dividend model

Welch Company is considering three independent projects, each of which requires a $3 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects is presented below:

Project H (High risk): Cost of capital = 15% IRR = 19%

Project M (Medium risk): Cost of capital = 11% IRR = 12%

Project L (Low risk): Cost of capital = 8% IRR = 10%

Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 50% debt and 50% common equity, and it expects to have net income of $8,383,500. If Welch establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to two decimal places.

Explanation / Answer

Project H Project M And Project L would be undertaken because their IRRs are more than the cost of capital

Fund Required 3000,000*3 9000000 Equity 50% 4500000 Dividend = Net income - needed equity 8,383,500-4500000 =3883500 Payout ratio Dividend/Net income=3883500/8383500 46.32%

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