Bankston Corporation forecasts that if all of its existing financial policies ar

Question

Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?

a. Increase the percentage of debt in the target capital structure. b. Increase the proposed capital budget. c. Reduce the amount of short-term bank debt in order to increase the current ratio. d. Reduce the percentage of debt in the target capital structure. e. Increase the dividend payout ratio for the upcoming year.

Explanation / Answer

Answer - a - Increase the percentage of debt in target capital structure

Cot of debt is relatively less than cost of equity owing to less risk involved in debt. Hence, in order to finance the capital budget, increasing the percentage of debt, i.e. opting for debt financing will help the company lower weighted average cost of capital

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