Quantitative Problem: Lane Industries is considering three independent projects,
ID: 2784464 • Letter: Q
Question
Quantitative Problem: Lane Industries is considering three independent projects, each of which requires a $2.3 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here: Cost of capital 16% IRR = 18% Project H (high risk): Project M (medium risk): Cost of capital = 10% IRR = 8% Project L (low risk): Note that the projects' costs of capital vary because the projects have different levels of risk. The company's optimal capital structure calls for 40% debt and 60% common equity, and it expects to have net income of $4,100,000. If Lane establishes its dividends from the residual dividend model, what will be its payout ratio? Round your answer to 2 decimal places. Cost of capital 11% IRR 12%Explanation / Answer
Project M is to be rejected as its IRR is less than its risk adjusted cost of capital of 10%. The other two projects are acceptable. The required capital for the two projects = 2300000*2 = 4600000 The equity requirement, given the desired capital structure is 4600000*0.60 = $2760000. The amount available for dividend under the residual model = 4100000-2760000 = $1340000 The pay out ratio = 1340000/4100000 =32.68% (Answer)