The Clydesdale Corporation has an optimal capital structure consisting of 70 per
ID: 2767131 • Letter: T
Question
The Clydesdale Corporation has an optimal capital structure consisting of 70 percent debt and 30 percent equity. The marginal cost of capital is calculated to be 14.75 percent. Total earnings available to common stockholders for the coming year total $1,200,000. Investment opportunities are:
Project
Investment
IRR (%)
A
$1,000,000
22
B
$750,000
18
C
$1,250,000
15
D
$500,000
14
a. According to the residual dividend theory, what should the firm's total dividend payment be?
b. If the firm paid a total dividend of $675,000, and restricted equity financing to internally generated funds, which projects should be selected? Assume the marginal cost of capital is constant.
Project
Investment
IRR (%)
A
$1,000,000
22
B
$750,000
18
C
$1,250,000
15
D
$500,000
14
Explanation / Answer
(a) Residual dividend for the firm = 1,200,000 - (1,200,000*14.75%) = $1,023,000
(b) Capital leftover = 1,200,000 - 675,000 = $525,000
The company should select Project D