If a firm uses external financing as a plug item, has a new capital budget of $2 million, a net income of $3 million, and a plowback ratio of 40%, how much should be raised in external funds?

Question

Quizplus · Accepted Answer

Since the plowback ratio is 40%, it means that $1.2 million will be reinvested into the firm. Therefore, the amount of funds that need to be raised from external sources will be equal to the difference between the capital budget and the amount being plowed back into the firm. Thus, $2 million - $1.2 million = $800,000 should be raised in external funds. Therefore, the correct answer is C.

If a Firm Uses External Financing as a Plug Item