(Residual dividend policy) FarmCo, Inc follows a policy of paying out cash
dividends equal to the residual amount that remains after funding 50 percent of it planned capital
expenditures. The firm tries to maintain a 50 percent debt and 50 percent equity capital structure
and does not plan on issuing more stock in the coming year. FarmCos CFO has estimated that
the firm will earn $13 million in the current year.
a. If the firm maintains its target financing mix and does not issue any equity next year,
what is the most it could spend on capital expenditures next year given its earnings
b. If FarmCo capital budget for next year is $10 million, how much will the firm pay in
dividends and what is the resulting dividend payout percentage?