Question

Whitman Antique Cars Inc. has the following data, and it follows the residual dividend model. Some Whitman family members would like more dividends, and they also think that the firm's capital budget includes too many projects whose NPVs are close to zero. If Whitman reduced its capital budget to the indicated level, by how much could dividends be increased, holding other things constant?Original capital budget $3,000,000New capital budget $2,150,000Net income $3,500,000% Debt 35%

Answer 1

The dividends could be increased by $552,500.

Step-by-step explanation:

Using the residual dividend model, the dividend is calculated as follows.

Dividend = Net income - (Target equity ratio x Capital budget)

Target equity ratio = 1 - Debt ratio

= 1 - 0.35

= 0.65

For original capital budget: Dividend = $3,500,000 - (0.65 x $3,000,000)

= $1,550,000

For new capital budget: Dividend = $3,500,000 - (0.65 x $2,150,000)

= $2,102,500

Increase in dividend = New dividend - Old dividend

= $2,102,500 - $1,550,000

= $552,500