# residual div policy

Pages: 1 (317 words) Published: April 20, 2015
﻿Allarco Inc. predicts that earnings in the coming year will be \$90,000,000. There are 20,000,000 shares and Allarco Inc. maintains a debt-equity ratio of 6.50.

a) Calculate the maximum investment funds available without issuing new equity.  The correct answer was:  \$675,000,000.00
To reinvest the whole earnings without any equity financing and to keep the debt-equity ratio the same, the maximum funds available is \$90,000,000 + (6.50 × \$90,000,000) = \$675,000,000

b) What will be the increase in borrowing to have the above investment funds?  The correct answer was:  \$585,000,000.00
To keep the debt-equity ratio the same, the new borrowing should be \$675,000,000 - \$90,000,000 = \$585,000,000

c) Suppose the firm uses residual policy. Planned capital expenditures total \$45,000,000. Based on this information, what will the dividend per share be?  The correct answer was:  \$4.20 share
D/E = 6.50 implies capital structure is (2/15) equity and (13/15) debt  Equity portion of investment plan = (2/15) × \$45,000,000 = \$6,000,000. Residual = \$90,000,000 - \$6,000,000 = \$84,000,000 Dividend per share = \$84,000,000/20,000,000 share(s) = \$4.20 per share

d) In part (c), how much borrowing will take place?
To keep the debt-equity ratio the same, the new borrowing should be \$45,000,000 - \$6,000,000 = \$39,000,000

e) In part (c), What is the addition to retained earnings?  The correct answer was:  \$6,000,000.00
The total dividend is \$90,000,000 - (2/15) × \$45,000,000 = \$84,000,000 Addition to retained earnings = \$90,000,000 - \$84,000,000 = \$6,000,000

f) Suppose Allarco Inc. plans no capital outlays for the coming year. What will the dividend per share be under a residual policy?  The correct answer was:  \$4.50 per share
Since there's no capital outlay for the coming year, the total dividend is \$90,000,000. The dividend per share is \$90,000,000/20,000,000 share(s) = \$4.50 per share

g) In part (f), what will new...