(14–9)

Residual Distribution Policy The Welch Company is considering three independent projects, each of which requires a $5 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are as follows:

Project H (high risk): Cost of capital = 16%; IRR = 20%

Project M (medium risk): Cost of capital = 12%; IRR = 10%

Project L (low risk): Cost of capital = 8%; IRR = 9%

Note that the projects’ cost of capital varies because the projects have different levels of risk. The company’s optimal capital structure calls for 50% debt and 50% common equity. Welch expects to have net income of $7,287,500. If Welch bases its dividends on the residual model (all distributions are in the form of dividends), what will its payout ratio be?

CHALLENGING PROBLEMS 10–11