Kendra Brown is analyzing the capital requirements for Reynolds Corporation for
ID: 2790504 • Letter: K
Question
Kendra Brown is analyzing the capital requirements for Reynolds Corporation for next year. Kendra forecasts that Reynolds will need $14 million to fund all of its positive-NPV projects, and her job is to determine how to raise the money. Reynolds's net income is $10 million, and it has paid a $4.00 dividend per share (DPS) for the past several years (1.0 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company's target capital structure is 40% debt and 60% equity.
Suppose that Reynolds's management is firmly opposed to cutting the dividend; that is, it wishes to maintain the $4.00 dividend for the next year. Suppose also that the company is committed to funding all profitable projects and is willing to issue more debt (along with the available retained earnings) to help finance the company's capital budget. Assume the resulting change in capital structure has a minimal impact on the company's composite cost of capital, so that the capital budget remains at $14 million. What portion of this year's capital budget would have to be financed with debt? Round your answer to two decimal places.
Suppose once again that Reynolds's management wants to maintain the $4.00 DPS. In addition, the company wants to maintain its target capital structure (40% debt, 60% equity), and its $14 million capital budget. What is the minimum dollar amount of new common stock the company would have to issue in order to meet all of its objectives? Round your answer to the nearest dollar.
Now consider the case in which Reynolds's management wants to maintain the $4.00 DPS and its target capital structure but also wants to avoid issuing new common stock. The company is willing to cut its capital budget in order to meet its other objectives. Assuming the company's projects are divisible, what will be the company's capital budget for the next year? Round your answer to the nearest dollar.
Explanation / Answer
Total Capital required = $14 milllion.
Current proportion of equity = 60%
Net year Net Income = $10 million
a.
if company maintain current dividend payment of $4 per share, then
Total retained earnings it can use = $10 million - ($4 × 1 million)
= $6 million.
if company maintain current dividend payment of $4 per share, then total retained earnings it can use for capital project is $6 million.
So, total debt need to issue = $14 - $6
= $8 million.
Portion of capital finance with debt = $8 / $14
= 57.14%
Portion of capital finance with debt is 57.14%.
b.
Minimum Dollar amount of equity issue = ($14 × 60%) - $6
= $8.40 million - $6 million
= $2.40 million.
Company need to issue $2.40 million worth of new equity to maintain current dividend paymenta nd current capital structure.
c.
Value of capital budget to meet all objective = $6 / 60%
= $10 million.
Value of capital budget to meet all objective is $10 million.
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