Flavortech expects EBIT of $2,000,000 for the current year. The firm's capital structure consists of 40% debt and 60% equity and its marginal tax rate is 40%. The cost of equity is 14% and the company pays a 10% rate on its $5,000,000 of long term debt. One million shares of common stock are outstanding. For next year the firm expects to fund one large positive NPV project costing $900,000 and it will fund this project in accordance with its target capital structure. 1. If the firm followsa residual distribution policy (with all distributions in the form of dividends) and has no other projects, what is its expected dividend payout ratio? 2. If the firm follows a 30% constant payout dividend policy, does it have sufficient retained earnings to fund the equity portion of its capital investment? 3. Which policy should the firm pursue to minimize its cost of capital?

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