Question

The Wei Corporation expects next year’s net income to be $15 million. The firm is currently financed with 40% debt. Wei has $12 million of profitable investment opportunities, and it wishes to maintain its existing debt ratio. According to the residual distribution model (assuming all payments are in the form of dividends), how large should Wei’s dividend payout ratio be next year?

Answer 1

Answer:

52%

Explanation:

Before diving into the use of residual distribution model, first, let us specify what our Total Investment required, Equity, Next year net income is:

Total Investment Required = 12,000,000

Equity  = 12,000,000 × (1 - 40%) = 7,200,000

Next Year Net income = 15,000,000

Using the residual distribution model , we can specify that,

Retention Amount of Net income = Equity required = 7,200,000

and,

Dividend Distribution = Net income - Retention Amount of Net income

==> Dividend Distribution = 15,000,000 - 7,200,000

==> Dividend Distribution = 7,800,000

Therefore,

Payout ratio = Dividend Distribution ÷ Net income

==> Payout ratio = 7800000 ÷ 15000000  = 0.52

Therefore, the Payout ratio for next year will be 52%