United Builders wants to maintain a target capital structure with 30% debt and 70% equity.Its forecasted net income is $550,000, and because of market conditions, the company will not issue any new stock during the coming year.If the firm follows the residual dividend policy, what is the maximum capital budget that is consistent with maintaining the target capital structure?
A) $673,652
B) $709,107
C) $746,429
D) $785,714
E) $825,000

Question

Quizplus · Accepted Answer

To maintain the target capital structure of 30% debt and 70% equity, United Builders needs to ensure that for every $0.70 of equity, there is $0.30 of debt in financing its projects. Given that the firm will not issue new stock, all equity financing will come from its net income of $550,000. To find the maximum capital budget, we calculate the total amount of financing (debt + equity) that maintains the 70% equity to 30% debt ratio. Equity portion = Net income = $550,000 (which is 70% of the total financing needed)To find the total financing, we set up the equation: $550,000 = 70% of Total FinancingTotal Financing = $550,000 / 0.70 = $785,714Thus, the maximum capital budget that maintains the target capital structure, without issuing new stock and using the residual dividend policy, is $785,714.

United Builders Wants to Maintain a Target Capital Structure with 30