Driver Corporation faces an IOS schedule calling for a capital budget of $60 million.Its optimal capital structure is 60 percent equity and 40 percent debt.Its earnings before interest and taxes (EBIT)were $98 million for the year.The firm has $200 million in assets,pays an average of 10 percent on all its debt,and faces a marginal tax rate of 34 percent.If the firm maintains a residual dividend policy and will keep its optimal capital structure intact,what will be the amount of the dividends it pays out after financing its capital budget?
A) $23.4 million
B) $59.4 million
C) $20.76 million
D) $30.0 million
E) $0

Question

Quizplus · Accepted Answer

The correct answer is A.The firm's EBIT is $98 million, and its interest expense is $200 million * 10% = $20 million. So, its net income is $98 million - $20 million = $78 million. The firm's capital budget is $60 million, so its residual income is $78 million - $60 million = $18 million. The firm's optimal capital structure is 60% equity and 40% debt, so its equity portion of the residual income is $18 million * 60% = $10.8 million. The firm's dividends are equal to its residual income minus its equity portion of the residual income, so its dividends are $18 million - $10.8 million = $7.2 million.

Driver Corporation Faces an IOS Schedule Calling for a Capital