Problem 14-9 Residual Distribution Policy Harris Company must set its investment
ID: 2382504 • Letter: P
Question
Problem 14-9
Residual Distribution Policy
Harris Company must set its investment and dividend policies for the coming year. It has three independent projects from which to choose, each of which requires a $4 million investment. These projects have different levels of risk, and therefore different costs of capital. Their projected IRRs and costs of capital are as follows:
Harris intends to maintain its 40% debt and 60% common equity capital structure, and its net income is expected to be $13,459,500. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be? Round your answer to two decimal places.
Project A: Cost of capital = 15%; IRR = 16% Project B: Cost of capital = 10%; IRR = 12% Project C: Cost of capital = 7%; IRR = 8%Explanation / Answer
Total investment required for each project - $ 4 million
For three project the total investment required would be = 4,000,000 * 3 = 12,000,000
Common equity required = 12,000,000 * 60%
= 7,200,000
Net income expected = 13,459,500
Since the firm has $13,459,500 of net income only $6,259,500 will be left for dividends.
Payout ratio = dividends/net income
= 6,259,500 / 13,459,500 = 46.51%