DeAngelo Corp.'s projected net income is $150.0 million,its target capital structure is 25% debt and 75% equity,and its target payout ratio is 65%.DeAngelo has more positive NPV projects than it can finance without issuing new stock,but its board of directors has decreed that it cannot issue any new shares in the foreseeable future.The CFO now wants to determine how the maximum capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy.Versus the current policy,how much larger could the capital budget be if (1) the target debt ratio were raised to 75%,other things held constant; (2) the target payout ratio were lowered to 20%,other things held constant; and (3) the debt ratio and payout were both changed by the indicated amounts. $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $\text { Increase in Capital Budget }$
$\begin{array}{llll}
\hline &\text { Increase Debt to }& \text { Lower Payout to }\
&75 \% & 20 \% & \text {Do Both} \
\hline W . & \$ 120.0 & \$ 77.2 & \$ 351.5 \
\mathrm{X} . & \$ 126.4 & \$ 81.2 & \$ 370.0 \
\mathrm{Y} . & \$ 133.0 & \$ 85.5 & \$ 389.5 \
\mathrm{Z} . & \$ 140.0 & \$ 90.0 & \$ 410.0
\end{array}$
A)Choice W
B)Choice X
C)Choice Y
D)Choice Z

Question

DeAngelo Corp.'s projected net income is $150.0 million,its target capital structure is 25% debt and 75% equity,and its target payout ratio is 65%.DeAngelo has more positive NPV projects than it can finance without issuing new stock,but its board of directors has decreed that it cannot issue any new shares in the foreseeable future.The CFO now wants to determine how the maximum capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy.Versus the current policy,how much larger could the capital budget be if (1) the target debt ratio were raised to 75%,other things held constant; (2) the target payout ratio were lowered to 20%,other things held constant; and (3) the debt ratio and payout were both changed by the indicated amounts. $ \quad $ $ \quad $ $ \quad $ $ \quad $ $ \quad $ $\text { Increase in Capital Budget }$
$\begin{array}{llll}
\hline &\text { Increase Debt to }& \text { Lower Payout to }\
&75 \% &  20 \% & \text {Do Both} \
\hline W . & \$ 120.0 & \$ 77.2 & \$ 351.5 \
\mathrm{X} . & \$ 126.4 & \$ 81.2 & \$ 370.0 \
\mathrm{Y} . & \$ 133.0 & \$ 85.5 & \$ 389.5 \
\mathrm{Z} . & \$ 140.0 & \$ 90.0 & \$ 410.0
\end{array}$
A)Choice W
B)Choice X
C)Choice Y
D)Choice Z

Quizplus · Accepted Answer

The increase in the capital budget can be calculated by understanding how changes in the debt ratio and payout ratio affect the amount of internal financing available for new projects. Increasing the debt ratio to 75% would allow the company to finance more projects with debt rather than equity, thus preserving more of its equity for reinvestment rather than paying it out as dividends. Lowering the payout ratio to 20% would mean that a smaller portion of the net income is paid out as dividends, leaving more available for reinvestment in new projects. Doing both would maximize the amount of net income available for reinvestment, leading to the largest possible increase in the capital budget. The correct choice, D, reflects the highest increases across all scenarios, indicating the most efficient use of the company's net income for expanding its capital budget under the given constraints.

DeAngelo Corp \quad \quad \quad

DeAngelo Corp $\quad$ $\quad$ $\quad$