WorldTrans is a family owned concern. It has been using the residual dividend model, but family members who hold a majority of the stock want more cash dividends, even if that means a slower future growth rate. Neither the net income nor the capital structure will change during the coming year as a result of a dividend policy change to the indicated target payout ratio. By how much would the capital budget have to be cut to enable the firm to achieve the new target dividend payout ratio? Do not round intermediate calculations. % Debt 45% % Equity = 1.0 – % Debt 55% Capital budget under the residual dividend model $5,000,000 Net income; it will not change this year even if dividends increase $3,500,000 Equity to support the capital budget = % Equity × Capital budget $2,750,000 Dividends paid = NI – Equity needed $750,000 Currently projected dividend payout ratio 21.4% Target dividend payout ratio 43% Group of answer choices -$1,249,182 -$1,537,455 -$1,496,273 -$1,098,182 -$1,372,727
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
| % Debt |
45% |
| % Equity = 1.0 – % Debt |
55% |
| Capital budget under the residual dividend model |
$5,000,000 |
| Net income; it will not change this year even if dividends increase |
$3,500,000 |
| Equity to support the capital budget = % Equity × Capital budget |
$2,750,000 |
| Dividends paid = NI – Equity needed |
$750,000 |
| Currently projected dividend payout ratio |
21.4% |
| Target dividend payout ratio |
43% |
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