The following facts apply to your company:
Target capital structure: 50% debt; 50% equity.
EBIT:$200 million -
Assets:$500 million -
Tax rate:40%
Cost of new and old debt:8%
Based on the residual dividend policy, the payout ratio is 60 percent. How large (in millions of dollars) will the capital budget be?
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A. B. C. D. E.Explanation
Debt = 0.5(Assets) = 0.5($500) = $250 million.
Interest = 0.08($250) = $20 million.
EBT = EBIT - I = $200 - $20 = $180.
NI = $180 - Taxes = $180 - $180(0.4) = 0.6($180) = $108 million.
Dividends = $108(0.6) = $64.80 million.
Retained earnings = NI - D = $108.00 - $64.80 = $43.20 million.
Half of the capital budget will be debt, half will be common equity from retained earnings, so the capital budget will = $86.40 million.