Part 2. Using the residual dividend model. AR Tech Inc. projects the following d

Question

Part 2. Using the residual dividend model.
AR Tech Inc. projects the following data for the coming year.

EBIT                      $2,000,000         Capital budget     $850,000
Interest rate                    10%         % Debt                      40%
Debt outstanding    $5,000,000         % Equity                     60%
Shares outstanding   5,000,000         Tax rate                      30%

Assume the company follows the residual dividend policy and also maintains its target capital structure.
Question 1: Determine net income for AR Tech.  Check figure: net income = $1,050,000.
Question 2: Determine how much equity is needed for the capital budget.
Question 3: What is AR Tech's payout ratio?  Hint: First calculate how much in dividends the company will pay.

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Part 1:

Net Income = (EBIT - Interest)*(1 - Tax Rate) = (2000000 - 10%*5000000)*(1-30%) = 1050000

Part 2:

Equity Needed for Capital Budget = Capital Budget*% of Equity = 850000*60% = 510000

Part 3:

Dividend = Net Income - Equity Needed for Capital Budget = 1050000 - 510000 = 540000

Dividend Payout Ratio = Dividend/Net Income*100 = 540000/1050000*100 = 51.43%

Thanks.

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