Problem:
Harris Company must set its investment and dividend policies for the coming year. It has three independent projects from which to choose, each of which requires a $3 million investment. These projects have different levels of risk, and therefore different costs of capital. Their projected IRRs and costs of capital are as follows:
- Project A: Cost of capital = 18%; IRR = 16%
- Project B: Cost of capital = 10%; IRR = 15%
- Project C: Cost of capital = 7%; IRR = 10%
Required:
Harris intends to maintain its 55% debt and 45% common equity capital structure, and its net income is expected to be $9,687,000. If Harris maintains its residual dividend policy (with all distributions in the form of dividends), what will its payout ratio be?
Note: Please provide reasons to support your answer.