Redwood Systems follows a strict residual distribution policy (with all distributions in the form of dividends). The company estimates that its capital expenditures this year will be $40 million, its net income will be $30 million, and its target capital structure is 60 percent equity and 40 percent debt. What will be the company's dividend payout ratio?
A) 80%
B) 60%
C) 40%
D) 20%
E) 15%

Question

Quizplus · Accepted Answer

Under a residual distribution policy, dividends are paid from the residual or leftover equity after all capital expenditures are funded. With a target capital structure of 60% equity, Redwood Systems needs $24 million (60% of $40 million) in equity for capital expenditures. With a net income of $30 million, the residual available for dividends is $6 million. The dividend payout ratio is $6 million / $30 million = 20%.

Redwood Systems Follows a Strict Residual Distribution Policy (With All