Concept explainers
a)
To determine: Amount of retained earnings needed by company K to fund its capital budget.
a)
Explanation of Solution
Given information:
Capital budget is $15,000,000
Net income is $11 million,
DPS dividend per share is $2,
Outstanding shares 1 million,
Capital structure is 30% debt and 70% equity.
Calculation of retained earnings:
Therefore, retained earnings needed is amounted to $10,500,000
b)
To determine: Dividend per share (DPS) and pay-out ratio.
b)
Explanation of Solution
Based on the residual dividend model, the amount $500,000 ($11,000,000-$10,500,000) is available for dividends.
Calculation of dividend per share:
Therefore, dividend per share is $0.50
Calculation of pay-out ratio:
Therefore, pay-out ratio is 4.55%
c)
To determine: Amount of retained earnings needed by company K to fund its capital budget, if it maintains $2 DPS for next year.
c)
Explanation of Solution
Calculation of retained earnings:
Therefore, retained earnings available is amounted to $9,000,000
d)
To determine: Whether company maintains its current capital structure with its DPS and maintain $15 million capital budget without raising new common stock.
d)
Explanation of Solution
Person X views that, company does not maintain because, if it maintains $2 DPS, only $9 million of retained earnings is available for capital projects. However, if the firm is to keep up its current capital structure of $10.5 million of equity is needed. This may necessitate the company to issue $1.5 million of common stock.
e)
To determine: Portion of current year capital budget could have to be financed by debt.
e)
Explanation of Solution
Retained earnings available is $9,000,000
Calculation of Capital budget financed with Retained earnings:
Therefore, percentage of capital budget financed by retained earnings is 60%
Calculation of Capital budget financed with debt:
Therefore, percentage of capital budget financed by debt is 40%
f)
To determine: External (new) equity needed.
f)
Explanation of Solution
Calculation of retained earnings:
Therefore, retained earnings available is amounted to $9,000,000
Calculation of external equity needed:
Therefore, external (new) equity needed is $1,500,000
g)
To determine: Company’s capital budget for next year.
g)
Explanation of Solution
Calculation of retained earnings:
Therefore, retained earnings available is amounted to $9,000,000
Retained earnings availability is equals the required equity to find new capital budget.
Calculation of capital budget using required equity:
Hence, capital budget is $12,857,143
Therefore, if Company R cuts its capital budget from $15 million to $12.86 million, it will maintain its DPS $2.00, its current capital structure and still follow its residual dividend policy.
h)
To determine: Actions taken by company when its
h)
Explanation of Solution
Company can take any one of the following four actions,
- New issue of common stock,
- Cuts its capital budget,
- Company cuts the dividends,
- Change the capital structure by using more debt funds.
Company should realize that every of these actions is not while not consequences to its cost of capital, stock price or both.
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Chapter 14 Solutions
Financial Management: Theory & Practice
- Suppose that you are analysing the capital requirements for your Corporation for next year. You forecast that the company will need $15 million to fund all of its positive-NPV projects and you job is to determine how to raise the money. The corporation’s net income is $11 million, and it has paid a $2 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. H. If a firm follows the residual distribution policy, what actions can it take when its forecasted retained earnings are less than the retained earnings required to fund its capital budget? I. Define the term ‘Dividend Policy’? What are the main elements of the Dividend Policy? J. What are the different theories on investor preference for dividends? Explain each theory?arrow_forwardSuppose that you are analysing the capital requirements for your Corporation for next year. You forecast that the company will need $15 million to fund all of its positive-NPV projects and you job is to determine how to raise the money. The corporation’s net income is $11 million, and it has paid a $2 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. F. Suppose once again that management wants to maintain the $2 DPS. In addition, the company wants to maintain its target capital structure (30% debt, 70% equity) and its $15 million capital budget. What is the minimum dollar amount of new common stock the company would have to issue in order to meet all of its objectives? G. Now consider the case in which management wants to maintain the $2 DPS and its target capital structure but…arrow_forwardSuppose that you are analysing the capital requirements for your Corporation for next year. You forecast that the company will need $15 million to fund all of its positive-NPV projects and you job is to determine how to raise the money. The corporation’s net income is $11 million, and it has paid a $2 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. D. Can the company maintain its current capital structure, maintain its current dividend per share, and maintain a $15 million capital budget without having to raise new common stock? Why or why not? E. Suppose management is firmly opposed to cutting the dividend; that is, it wishes to maintain the $2 dividend for the next year. Suppose also that the company is committed to funding all profitable projects and is willing to issue more…arrow_forward
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- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT