DeAngelo Corp.\'s projected net income is $150.0 million, its target capital str

Question

DeAngelo Corp.'s projected net income is $150.0 million, its target capital structure is 25% debt and 75% equity, and its target payout ratio is 65%. DeAngelo has more positive NPV projects than it can finance without issuing new stock, but its board of directors had decreed that it cannot issue any new shares in the foreseeable future. The CFO now wants to determine how the maximum capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy. Versus the current policy, how much larger could the capital budget be if (1) the target debt ratio were raised to 75%, other things held constant, (2) the target payout ratio were lowered to 20%, other things held constant, and (3) the debt ratio and payout were both changed by the indicated amounts.
Increase in Capital Budget
Increase Debt to 75% Lower Payout to 20% Do Both

$114.0 $73.3 $333.9

$120.0 $77.2 $351.5

$126.4 $81.2 $370.0

$133.0 $85.5 $389.5

e) $140.0 $90.0 $410.0

$114.0 $73.3 $333.9

$120.0 $77.2 $351.5

$126.4 $81.2 $370.0

$133.0 $85.5 $389.5

e) $140.0 $90.0 $410.0

Explanation / Answer

Assumtions: Investment $500 Million Rate of Interest of Debt Amount is 6% Per Annum Net Income is before Interest on Debt Fund Let investment requirement is US$500 million. As per current policy Debt:Equity (25:75) & Payout 65% Debt:Equity (75:25) & Payout 65% Debt:Equity (25:75) & Payout 20% Debt:Equity (75:25) & Payout 20% (75:25) (25:75) (75:25) Total Capital                 500.00              500.00                500.00                500.00 Debt 25%                 125.00              375.00                125.00                375.00 Equity 75%                 375.00              125.00                375.00                125.00 Net Income                 150.00              150.00                150.00                150.00 Less: Interest on Debt Fund @ 6% PA                      7.50                18.75                     7.50                   18.75 Income available for Shareholders                 142.50              131.25                142.50                131.25 Return on Investment of Shareholders 38.00% 105.00% 38.00% 105.00% Payout                    92.63                85.31                   28.50                   26.25 Retained Earning                    49.88                45.94                114.00                105.00 Retained Earning % 13.30% 36.75% 30.40% 84.00%

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