Essential Oil Inc. expects EBIT of $2,000,000 for the coming year. The firm's capital structure consists...

 

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Essential Oil Inc. expects EBIT of $2,000,000 for the coming year. The firm's capital structure consists of 40% debt and 60% equity, and its tax rate is 30%. The cost of equity is 14% and the company pays a 10% rate on its $5,000,000 of long-term debt. One million shares of common stock are outstanding. In its next capital budgeting cycle, the firm expects to fund one large positive NPV project costing $1,500,000 and it will fund this project in accordance with its target capital structure. a) If the firm follows a residual dividend policy and has no other projects, what is its expected dividend payout ratio? (8 marks) b) If the firm follows a 30% constant payout dividend policy, does it have sufficient retained earnings to fund the equity portion of its capital investment? (5 marks) Which policy should the firm pursue to minimize its cost of capital? (2 marks) [Total: 15 marks] c) N.B. Round to the next $1 and use two decimal places for rates of return. Essential Oil Inc. expects EBIT of $2,000,000 for the coming year. The firm's capital structure consists of 40% debt and 60% equity, and its tax rate is 30%. The cost of equity is 14% and the company pays a 10% rate on its $5,000,000 of long-term debt. One million shares of common stock are outstanding. In its next capital budgeting cycle, the firm expects to fund one large positive NPV project costing $1,500,000 and it will fund this project in accordance with its target capital structure. a) If the firm follows a residual dividend policy and has no other projects, what is its expected dividend payout ratio? (8 marks) b) If the firm follows a 30% constant payout dividend policy, does it have sufficient retained earnings to fund the equity portion of its capital investment? (5 marks) Which policy should the firm pursue to minimize its cost of capital? (2 marks) [Total: 15 marks] c) N.B. Round to the next $1 and use two decimal places for rates of return.

Answer rating: 100% (QA)

Lets tackle each part of the question a Expected Dividend Payout Ratio with Residual Dividend Policy With a residual dividend policy the firm first fu... View the full answer