Malkor Instruments Company treats dividends as a residual decision. It expects to generate $2 million in net earnings after taxes in the coming year. The company has an all-equity capital structure, and its cost of equity capital is 15 percent. The company treats this cost as the opportunity cost of retained earnings.

Because of flotation costs and underpricing, the cost of common stock financing is lugher. It is 16 percent.

Chcpter 11 Dividend Policy: Theory and Practice 335

a. How much in dividends (out of the $2 million in earnings) should be paid if the company has $1.5 million in projects whose expected return exceeds 15 percent?

b. How much in dividends should be paid if it has $2 million in projects whose expected return exceeds 15 percent?

c. How much in dividends should be paid if it has $3 million in projects whose expected return exceeds 16 percent? What else should be done?