Walsh Company is considering three independent projects, each of which requires a $4 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here:

Project H (high risk) : Cost of Capital = 16% IRR = 19%

Project M (medium risk) : Cost of Capital = 12% IRR = 13%

Project L (low risk) : Cost of Capital = 9% IRR = 8%

Note that the project's 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 $7,500,000.

Required:

a. If Walsh establishes its dividends from the residual dividend model, what will be its payout ratio?

Question

Jaycee Bolton

Business

24 February, 05:05

Walsh Company is considering three independent projects, each of which requires a $4 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here:

Project H (high risk) : Cost of Capital = 16% IRR = 19%

Project M (medium risk) : Cost of Capital = 12% IRR = 13%

Project L (low risk) : Cost of Capital = 9% IRR = 8%

Note that the project's 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 $7,500,000.

Required:

a. If Walsh establishes its dividends from the residual dividend model, what will be its payout ratio?

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Answers (1)

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June · Answer 1

36%

Explanation:

The computation of the dividend payout ratio is shown below:

The dividend payout ratio is

= (Dividend : total net income) * 100

where,

Dividend = Net income - equity amount

The net income is $7,500,000

And, the equity amount is

= $8,000,000 * 60%

= $4,800,000

So, the dividend is

= $7,500,000 - $4,800,000

= $2,700,000

As we can see that the IRR is more than the cost of capital in case of project Project H and Project M so we take the equity amount of this two projects

Now the dividend payout ratio is

= ($2,700,000 : $7,500,000) * 100

= 36%