A Ltd has made a profit of Rs.1, 20,000. Its gearing ratio is 0.4 which is to be maintained. It cost
of capital is: debt 10%, equity 22%, retained earnings 20%. Four projects are under
consideration.
Investment Required Rate of Return on Investment
A Rs.60, 000 19%
B Rs.50, 000 18%
C Rs.80, 000 17%
D Rs.20, 000 16%
What amount should be paid as dividend?
To determine the amount that should be paid as dividend, we need to calculate the amount of profit that needs to be retained in order to maintain the gearing ratio of 0.4.
First, we need to calculate the total capital structure of A Ltd. The gearing ratio is the ratio of debt to equity, so we can determine the debt and equity amounts as follows:
Debt = Gearing ratio * Equity
Debt = 0.4 * Equity
Next, we can calculate the total capital structure:
Total capital structure = Debt + Equity + Retained earnings
Given that the cost of capital for debt is 10%, equity is 22%, and retained earnings is 20%, we can calculate the corresponding amounts:
Debt amount = Debt * (Cost of debt / 100)
Equity amount = Equity * (Cost of equity / 100)
Retained earnings amount = Retained earnings * (Cost of retained earnings / 100)
Finally, we can calculate the profit that needs to be retained:
Profit retained = Total capital structure - (Debt amount + Equity amount + Retained earnings amount)
Once we have determined the profit that needs to be retained, the remaining profit can be paid as dividends.
Let's calculate these values using the given data:
Debt = 0.4 * Equity
Debt = 0.4 * Rs.1, 20,000
Total capital structure = Debt + Equity + Retained earnings
Total capital structure = Debt + Equity + Rs.1, 20,000
Debt amount = Debt * (Cost of debt / 100)
Equity amount = Equity * (Cost of equity / 100)
Retained earnings amount = Retained earnings * (Cost of retained earnings / 100)
Profit retained = Total capital structure - (Debt amount + Equity amount + Retained earnings amount)
Dividend = Profit - Profit retained
By plugging in the values based on the given data, you can calculate the amount that should be paid as a dividend.