Margo, Inc. has planned investments of $1,750 for next year and an after-tax net income of $1,974 this year. The company has a residual dividend policy and maintains a .60 debt-equity ratio. How Much new debt is required to fund the investments for next year?

Question

Quizplus · Accepted Answer

Under a residual dividend policy, dividends are paid out of net income after funding investments. With a 0.60 debt-equity ratio, 60% of the investment is funded by debt. The equity portion is $1,974 - $1,750 = $224. The debt portion is 0.60/(1+0.60) * $1,750 = $656.25.