1) ADP Corporation is reviewing its capital budget for the upcoming year and is
ID: 2790149 • Letter: 1
Question
1) ADP Corporation is reviewing its capital budget for the upcoming year and is forecasting it would require $26,250,000 to fund all of its profitable (positive NPV) projects for the upcoming year. It has paid a $2.00 dividend per share for the past several years. The company's target debt to equity ratio is 1.5; it has 1,000,000 shares outstanding and its expected net income for the upcoming year is $11,000,000. (28 marks) How much equity financing will it need to fund its capital budget? (4 marks) If ADP follows a residual dividend policy, what will be the company's payout ratio and dividend per share? (6 marks) Suppose the firm wishes to maintain its $2.00 dividend for the upcoming year and the firm is committed to funding all positive NPV projects. If the firm wishes to maintain its target debt to equity ratio, what is the amount of new common stock the firm would have to issue in order to meet its objectives? (8 marks) Suppose the firm wishes to maintain its $2.00 dividend for the upcoming year and the firm is committed to funding all positive NPV projects. If the firm does not want to issue new shares and is willing to issue more debt, what portion of capital budget will be financed with debt? (Assume the change in capital structure will have a minimal impact on the WACC so the capital budget will remain at $26,250,000). (4 marks Suppose the firm wishes to maintain its $2.00 dividend for the upcoming year, is committed to maintaining its target debt to equity ratio and wants to avoid issuing any new shares. What is the maximum amount ADP can spend on its capital budget for the upcoming year? (6 marks) a) b) c) d) e)Explanation / Answer
a) Equity financing required to fund the CEB = 26250000*1/(1.5+1.0) = $ 10,500,000 Answer b) NI available for distribution under the residual dividend policy = $11,000,000-$10,500,000 = $ 500,000 Payout ratio = NI available for dividend/Net income = 500000/11000000 = 4.55% Answer Dividend per share = NI available for dividend/Number of shares = 500000/1000000 = $ 0.50 Answer c) Retained earnings available after paying $2 dividend = $11,000,000 - $2*1,000,000 = $ 9,000,000 Amount of new common stock to be issued to meet the target debt equity ratio of 1.5:1 = 10,500,000-9,000,000 = $ 1,500,000 Answer d) Amount to be financed with debt = 26250000*1.5/2.5+1,500,000 = $ 17,250,000 Portion of capital budget = 17250000/26250000 = 65.71% Answer e) Retained earnings available after paying $2 dividend = $11,000,000 - $2*1,000,000 = $ 9,000,000 Maximum capital spending possible with retained earnings and target debt/equity ratio = 9000000*2.5/1 = $ 22,500,000 Answer
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