CFAI vol 3 - corp fin - page 193 Cap spending plans = 15m earnings this year = 25m target debt/equity = 35/65 Cap spending will be funded by earnings. What is payout ratio under residual div approach? So i did (15*.65) = 9.75 amount of equity used to fund the capex to keep target D/E as stated in problem. 25-9.75 = 15.25 (whats left over of earnings after you fund equity portion of cap ex. AKA dividend) 15.25/25 = 61% payout ratio WRONG Book says 25-15 = 10 div 10/25 = 40% payout ratio Why would they totally disregard the D/E target cap structure they gave in the prob? even if you fund cap ex out of earnings, you still need to take into account the D/E target right?
EDIT: (Not sure it’s material but maybe) target debt/equity (market value) = 35/65
Is this q 21 or 22 in the EOC problems? read the question : says ENTIRE amount of capital budget is funded from earnings. So only remainder is available as dividend.
Target D/E and Acutal Market Value of D/E aren’t always equal. A company may move away from a Target D/E in order to take advantage of opportunites, make strategic moves, etc. Also, Target D/E is usually a longer time frame goal and isn’t always over the short term. I would focus on the fact that they already give you the Cap Spending requirement in that year’s budget. It is being funded by earnings, not by raising capital from issuing new debt or equity and try not overthink this one.