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Advantages and disadvantages of the residual policy

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Assume that ISI has an $800,000 capital budget planned for the coming year. You have determined that its present capital structure (60 percent equity and 40% debt) is optimal, and its net income is forecasted at $600,000. Use the residual dividend policy approach to determine ISI's total dollar dividend and payout ratio. In the process, explain what the residual dividend policy is, and use a graph to illustrate your answer.

Then explain what would happen if net income were forecasted at $400,000, or at $800,000.

(2) In general terms, how would a change in investment opportunities affect the payout ratio under the residual payment policy?

(3) What are the advantages and disadvantages of the residual policy? (Hint: Don't neglect signaling and clientele effects.)

Reference no: EM133061903

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