Brock Brothers wants to maintain its capital structure, which is 30 percent debt, and 70 percent equity. The company forecasts that its net income this year will be
$1,000,000. The company follows a residual dividend policy, and anticipates a dividend payout ratio of 40 percent. What is the size of the company's capital budget?
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A. B. C. D. E.A
Since the company expects to pay out 40% of net income or $400,000, it must expect to have $600,000 of retained earnings available for capital investment.
Given that the firm will finance new investment with 70% equity and 30% debt, $600,000 must represent 70% of the firm's capital budget, that is, $600,000 = (0.7)
CB or CB = $857,143.