The new intern is trying to understand the dividend policy of your firm. Having studied dividend policies at university, the intern wonders why the firm chose its dividend policy. The intern also wants to know how to estimate the dividend amount likely to be paid the following year. The following limited information is available:
(1) The firm follows a residual dividend policy.
(2) The total capital budget for next year is dependent on the outcome of a feasibility study, and will either be $1.5 million, $2.5 million, or $3.5 million.
(3) The forecasted level of retained earnings for next year is $2.2 million.
(4) The firm wants to maintain a debt ratio of 60%.
a. Describe the purpose of a residual dividend policy.
b. Calculate the expected amount of the dividend, if any, for each of the three capital budget amounts.
c. Explain why there are differences in the amounts of the dividend for the three capital budget amounts.