Lahore School of Economics

Financial Management II
Distributions to Shareholders: Dividends and Share Repurchases – 1
Assignment 18 Solution
Problems for Assignment
Q1) Equity retained = 0.3($3,000,000) = $900,000.

NI $2,000,000
– Additions to RE 900,000
Earnings remaining $1,100,000

$1,100,000
Payout = $2,000,000

Q2) Retained earnings = Net income (1 – Payout ratio)

= $5,000,000(0.55) = $2,750,000.
 Internal equity available = $2,750,000

Total equity required = (New investment)(1 – Debt ratio)

= $10,000,000(0.60) = $6,000,000.

New external equity needed = $6,000,000 – $2,750,000 = $3,250,000.

Examples

Q1)
Dividends  Net income    Target Equity Ratio    Total Capital Budget  
= 35 m – (0.55 x 30 m)
= 35 – 16.5
= $18.5 m

Dividend Payout Ratio = Total Dividends / Net Income = $18.5 m / 35 m = 52.86%

Q2)
d. If the payout ratio was continued at 20%, even after internal investment opportunities had declined, the price of
the stock would drop to $2/(0.14 - 0.06) = $25 rather than to $75. Thus, an increase in the dividend payout is
consistent with maximizing shareholder wealth.