Small town Diners has a policy of treating dividends as a passive residual. It forecasts that net

earnings after taxes in the coming year will be $500,000. The firm has earned the same $500,000

for each of the last five years and has paid between $200,000 and $350,000 out in dividends in

each of those years. The company is financed entirely with equity and its cost of equity capital is

12 percent.

1. How much of the coming year's earnings should be paid out in dividends if the company has

$400,000 in projects whose expected returns exceed 12 percent?

2. How much should be paid out if the company has investment projects of $5,000,000 whose

expected return is greater than 12 percent?