A corporation expects to have earnings available to common shareholders (net income minuspreferred dividends) of $1,000,000 in the coming year. The firm plans to pay 40 percent of earningsavailable in cash dividends. If the firm has a target capital structure of 40 percent long-term debt,10 percent preferred stock, and 50 percent common stock equity, what capital budget could thefirm support without issuing new common stock?
A) $800,000
B) $600,000
C) $2,000,000
D) $1,200,000

Question

Quizplus · Accepted Answer

The firm plans to pay 40% of $1,000,000 in dividends, leaving 60% or $600,000 for reinvestment. With a target capital structure of 50% equity, the total capital budget supported is $600,000 / 0.50 = $1,200,000.

A Corporation Expects to Have Earnings Available to Common Shareholders