Question

Warren Supply Inc. is evaluating its capital budget. The company finances with debt and common equity, but because of market conditions, wants to avoid issuing any new common stock during the coming year. It is forecasting an EPS of $3.00 for the coming year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $725,000, and it is committed to maintaining a $2.00 dividend per share. Given these constraints, what percentage of the capital budget must be financed with debt?

Select the correct answer.

Answer 1

Solution:-

To Calculate percentage of the capital budget must be financed with debt-

Net Income = EPS * Shares Outstanding

Net Income = $3 * 500,000

Net Income = $1,500,000

Dividend Paid = DPS * Shares Outstanding

Dividend Paid = $2 * 500,000

Dividend Paid = $1,000,000

Retained Earning Available = Net Income - Dividend Paid

Retained Earning Available = $1,500,000 - $1,000,000

Retained Earning Available = $500,000

Debt Needed = Capital Budget - Retained Earning

Debt Needed = $725,000 - $500,000

Debt Needed = $225,000

% Debt Financing =

% Debt Financing =

% Debt Financing = 31.03%

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