Chapter 15, Problem 3MC

1. (1) Assume that IWT has completed its IPO and has a $112.5 million capital budget planned for the coming year. You have determined that its present capital structure (80% equity and 20% debt) is optimal, and its net income is forecasted at $140 million. Use the residual distribution approach to determine IWT’s total dollar distribution. Assume for now that the distribution is in the form of a dividend. Suppose IWT has 100 million shares of stock outstanding. What is the forecasted dividend payout ratio? What is the forecasted dividend per share? What would happen to the payout ratio and DPS if net income were forecasted to decrease to $90 million? To increase to $160 million?
2. (2) In general terms, how would a change in investment opportunities affect the payout ratio under the residual distribution policy?
3. (3) What are the advantages and disadvantages of the residual policy? (Hint: Don’t neglect signaling and clientele effects.)