A firm has $50 million in assets and its optimal capital structure is 60% equity. If the firm has $12 million in retained earnings, at what asset level will the firm need to issue additional stock? (Assume no growth in retained earnings.)

Question

Quizplus · Accepted Answer

The optimal capital structure is 60% equity, which means that the firm can have $20 million in debt ($50 million assets * 0.4 debt ratio) and $30 million in equity ($50 million assets * 0.6 equity ratio). The firm currently has $12 million in retained earnings, which means it can add another $18 million in equity without issuing additional stock ($30 million equity - $12 million retained earnings). Therefore, the firm can increase its assets to $20 million ($20 million assets * 0.6 equity ratio = $12 million equity needed) before needing to issue additional stock.

A Firm Has $50 Million in Assets and Its Optimal