1) Quinlan Electrical has quite a few positive NPV projects from which to choose
ID: 2718893 • Letter: 1
Question
1) Quinlan Electrical has quite a few positive NPV projects from which to choose. The problem is that it has more of these projects than it can finance without issuing new stock and the board of directors refuses to issue any new shares in the foreseeable future. Norton'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%. 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.
Explanation / Answer
The maximum capital budget has been determined with the use of following table:
Based on the above calculations, the maximum capital budget would be in 140,90 and 410.
Current Option 1 Option 2 Option 3 Net Income 150 150 150 150 Debt Percentage 25% 75% 25% 75% Equity Percentage (100% - Debt Percentage) 75% 25% 75% 25% Payout Percentage 65% 65% 20% 20% Dividends (Net Income*Payout Percentage) 97.5 (150*65%) 97.5 (150*65%) 30 (150*20%) 30 (150*20%) Retained Earnings (Net Income – Dividends) 52.5 (150 - 97.5) 52.5 (150 - 97.5) 120 (150 - 30) 120 (150 - 30) Maximum Capital Budget (Retained Earnings/Equity Percentage) 70 (52.5/75%) 210 (52.5/25%) 160 (120/75%) 480 (120/25%) Change (Increase) in Budget (Option Amount – Current) 0 $140 (210-70) $90 (160-70) $410 (480-70)Related Questions
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