Walsh Company is considering three independent projects, each of which requires a $4 million investment. The estimated internal rate of return (IRR) and cost of capital for these projects are presented here:
Project H (high risk): Cost of Capital = 16% IRR = 19%
Project M (medium risk): Cost of Capital = 12% IRR = 13%
Project L (low risk): Cost of Capital = 9% IRR = 8%
Note that the project’s costs of capital vary because the projects have different levels of risk. The company’s optimal capital structure calls for 40% debt and 60% common equity, and it expects to have net income of $7,500,000.
Required:
a. If Walsh establishes its dividends from the residual dividend model, what will be its payout ratio?