25. The Scanlon Company’s optimal capital structure calls for 50 percent debt. T

Question

25. The Scanlon Company’s optimal capital structure calls for 50 percent debt. The interest rate on its debt is a constant 10 percent; its cost of common equity from retained earnings is 14 percent; the cost of equity from new stock is 17 percent; and its marginal tax rate is 40 percent. Scanlon has the following investment opportunities; Project A: Cost = $5 million; IRR = 20% Project B: Cost = $5 million; IRR = 12% Project C: Cost = $5 million; IRR = 11% Scanlon expects to have net income of $7,287, 500. If Scanlon bases its dividends on the residual policy, what will its payout ratio be?

Explanation / Answer

ANSWER:

cost of debt = 10%

cost of equity =17%

cost of retained earnings =14%

tax rate =40%

PROJECT A = $ 5million

PROJECT B = $5million

dividend on project A = $5million *20%

=1000000

payout ratio =1000000/7287500

=88.33%

dividend on project b = $5million *12%

=600000

payout ratio= 82.33%

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