Kendra Brown is analyzing the capital requirements for Reynold Corporation for next

year. Kendra forecasts that Reynold will need $15 million to fund all of its positive-NPV

projects and her job is to determine how to raise the money. Reynold's net income is $11

million, and it has paid a $2 dividend per share (DPS) for the past several years (1 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 30% debt and

70% equity.

a. Suppose Reynold follows the residual model and makes all distributions as dividends.

How much retained earnings will it need to fund its capital budget?

b. If Reynold follows the residual model with all distributions in the form of dividends,

what will be its dividend per share and payout ratio for the upcoming year?

c. If Reynold maintains its current $2 DPS for next year, how much retained earnings

will be available for the firm's capital budget?

d. Can Reynold maintain its current capital structure, maintain its current dividend per

share, and maintain a $15 million capital budget without having to raise new

common stock? Why or why not?

e.

Suppose management is firmly opposed to cutting the dividend; that is, it wishes to

maintain the $2 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 $15 million. What portion of this

year's capital budget would have to be financed with debt?

f. Suppose once again that management wants to maintain the $2 DPS. In addition, the

company wants to maintain its target capital structure (30% debt, 70% equity) and its

$15 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?

& Now consider the case in which management wants to maintain the $2 DRS 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?

h. If a firm follows the residual distribution policy, what actions can it take when its

forecasted retained earnings are less than the retained earnings required to fund its

capital budget?