Question

Chancellor Industries has retained earnings available of $1. 2 million. The firm plans to make two investments that require financing of $950,000 and $1. 75 million, respectively. Chancellor uses a target capital structure with 60% debt and 40% equity. Apply the residual theory to determine what dividends, if any, can be paid out, and calculate the resulting dividend payout ratio

Answer 1

Using the residual theory, the dividends to be paid out will be $120, 000 and the dividend payout ratio would be 10%.

How to find the dividends?

Using the residual theory, the dividends to be paid out is the amount remaining after the amount that was financed by equity is taken out of the retained earnings.

In this case therefore, the dividend is:

= Retained earnings - Investment from equity

= 1, 200, 000 - [ ( 950, 000 + 1, 750, 000) x 40%)

= $120, 000

Given the dividend, the dividend payout ratio would be:

= Dividends / Retained earnings

= 120, 000 / 1, 200, 000

= 10%

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