The Wagner Company Tries to Follow a Pure "Residual" Dividend

question 32

Multiple Choice

The Wagner Company tries to follow a pure "residual" dividend policy. Earnings and dividends last year were $100 million and $20 million, respectively. Anticipated earnings for this year are $80 million. The company is financed completely with common equity. The required rate of return on retained earnings is 15% while the cost of new equity is 16%. Assuming Wagner has $90 million of investment projects having expected returns greater than 16%, determine Wagner's dividend and investment policies.

• A) Pay out $20 million in dividends and raise $30 million externally
• B) Pay no dividends and invest only in the first $80 million in projects.
• C) Pay out $10 million in dividends and raise $20 million externally
• D) Pay no dividends and raise $10 million externally

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Definitions:

Cost-Volume-Profit Analysis

The examination of the relationships among selling prices, sales and production volume, costs, expenses, and profits.

Contribution Margin

The amount of revenue remaining after deducting variable costs, which contributes to covering fixed costs and generating profit.

Gross Profit

The financial metric indicating the difference between revenue and the cost of goods sold, showcasing how efficiently a company is producing or sourcing its products.

Contribution Margin Ratio

The percentage of each sales dollar that remains after variable costs are subtracted, contributing to covering fixed costs and profit.