Question
Kendra Brown is analyzing the capital requirements for Reynolds Corporation for next year. Kendra forecasts that Reynolds will need $25 million to fund all of
Kendra Brown is analyzing the capital requirements for Reynolds Corporation for next year. Kendra forecasts that Reynolds will need $25 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 $16 million, and it has paid a $3 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 40% debt and 60% equity.
Suppose Reynolds's management is firmly opposed to cutting the dividend; that is, it wishes to maintain the $3 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 $25 million. What portion of this year's capital budget would have to be financed with debt?
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