Pavlin Corp.'s projected capital budget is $2,000,000, its target capital structure is 40% debt and 60% equity, and its forecasted net income is $1,150,000. If the company follows the residual dividend model, how much dividends will it pay or, alternatively, how much new stock must it issue?

Dividend to be paid by Pavlin Corp $0

Stock to be issued $50,000

(1,200,000-1,150,000)

Explanation:

The residual theory of dividend policy is that the optimal amount of dividends should be decided as follows.

If a company has capital investment opportunities that will have a positive NPV, it should invest in them because they will add to the value of the company and its shares.

The capital to invest in these projects should be obtained internally (from

earnings) if possible.

The amount of dividends paid by a company should be the residual amount of earnings remaining after all these available capital projects have been funded by retained earnings.

In this way, the company will maximise its total value and the market price of its shares.

Since the Company projected capital budget amounting to $2,000,000 needs 60% of the equity which will require $1,200,000 and net income is $1,150,000 therefore the Pavlin corp will utilize all its net income in equity financing and it will be further required to raise $50,000 (1,200,000-1,150,000) through stock issue.

So based on the above discussion, the following is the answer:

Dividend to be paid by Pavlin Corp $0

Stock to be issued $50,000

(1,200,000-1,150,000)