Reference no: EM132543077

As a manager of Addis garments, you have just received a letter from a key stockholder. The stockholder asks about the company's dividend policy. In fact, the stockholder has asked you to estimate the amount of the dividend that you are likely to pay next year.

You have not yet collected all the information about the expected dividend payment, but you do know the following:

a. The company follows a residual dividend policy.

b. The total capital budget for next year is likely to be one of three amounts, depending on the results of capital budgeting studies that are currently under way. The capital expenditure amounts are Birr 100,000, Birr 200,000, and Birr 300,000.

c. The forecasted level of potential retained earnings next year is Birr150, 000.

d. The target or optimal capital structure is a debt ratio of 50%.

Discuss the following questions:

Question 1: Describe a residual dividend policy.

A residual policy is when companies first use the cash flow to fulfill necessary capital expenditures. Once the capital amount available (the residual) is used to fund dividend payments.

Question 2: Compute the amount of the dividend (or the amount of new common stock needed) and the dividend payout ratio for each of the three capital expenditure amounts.

Question 3: Compare, contrast, and discuss the amount of dividends (calculated in part 1.2) associated with each of the three capital expenditure amounts.