Problem 14-09 Residual Distribution Policy Harris Company must set its investmen
ID: 2791873 • Letter: P
Question
Problem 14-09
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 $3 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 60% debt and 40% common equity capital structure, and its net income is expected to be $6,659,500. 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.
Problem 14-09
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 $3 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:
Project A: Cost of capital = 15%; IRR = 21% Project B: Cost of capital = 13%; IRR = 14% Project C: Cost of capital = 7%; IRR = 6%Harris intends to maintain its 60% debt and 40% common equity capital structure, and its net income is expected to be $6,659,500. 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.
Explanation / Answer
Solution: Payout ratio = 81.98 % Working Notes: Capital budget = $3 million As Harris intends to maintain its 60% debt and 40% common equity capital structure. Distributions = Net Income – [(Target Equity Ratio) x (Total Capital Budget)] = $6,659,500 - [(40%) x $3,000,000] = $6,659,500 -$1,200,000 = $5,459,500 Dividend payout ratio = Distribution / net income = $5,459,500/$6,659,500 = 0.819806292 =81.98% Please feel free to ask if anything about above solution in comment section of the question.