Question 3. (15 points) Tarmac Corporation plans a $15 million expansion. The fi

Question

Question 3.   (15 points) Tarmac Corporation plans a $15 million expansion. The firm wants to maintain a 55 percent debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 20 percent of last year's net income. Last year, net income was $6 million.

a. Calculate the amount of external equity needed.

b. If the company changed to a residual dividend policy, how much external equity will it need?

c. Is the company likely to change to a residual policy? Why or why not?

Explanation / Answer

Answer

Investment= $ 15,000,0000

Debt to Total Assets Ratio 55 %

Equity to Assets Ratio 45 %

Total Equity Needed = $6,750,000

Net Income =$ 6000,000

Dividend Pay Out % = 20%

Dividend Paid = $ 1200,000

Retained Earnings = $ 4800000

External Equity Needed= Total Equity Needed -Retained Earnings

=$ 6750000-4800000

= $ 1950,000

b) Residual

Total Equity Needed = $ 6750,000

Net Income = $ 6000,000

External Equity Needed = $ 750000

c) Yes,The company is likely to change to a Residual policy .With the residual Policy model no dividends are paid out, thus reducing the amount of external equity needed.

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