Question

FOR A) They want us to use the formula

Dividends = Retained Earnings - ( capital expenditure * target equity weight)

but when I do 2,000,000- (2,000,000 * .4) i get 1200000 and they say the answer is 800,000

are they wrong?

Answer 1

ANSWER

$\rightarrow$ FORMULA used is Correct BUT you are using WRONG VALUES

$\rightarrow$ Under Resudual Dividend Policy, first we pay dividend only from left over earnings.

$\rightarrow$ So from the Retained Earnings we have to Reduce that much Amount of Capital Expenditure that would be borne by Equity holders. So we have to MULTIPLY BY EQUITY RATIO and NOT DEBT RATIO

a) 1st part

DIVIDEND AMOUNT = Retained Earnings - Amount of Capital Exp that will be Borne by Equity

= Retained Earnings - (Capital Exp * Equity Weight)

= 2000000 - { 2000000 * (1-0.4) }

=2000000 - { 2000000 * 0.6 }

= 2000000 - 1200000

= 800000

a) 2nd part

Dividend Payout Ratio = { Dividend Amount / Retained Earnings } * 100

= { 800000 / 2000000 } * 100

= 40 %

a) 3rd part

DIVIDEND AMOUNT = Retained Earnings - Amount of Capital Exp that will be Borne by Equity

= Retained Earnings - (Capital Exp * Equity Weight)

= 2000000 - { 3000000 * (1-0.4) }

=2000000 - { 3000000 * 0.6 }

= 2000000 - 1800000

= 200000