Clanton Company is financed 75 percent by equity and 25 percent by debt.If the firm expects to earn $30 million in net income next year and retain 40% of it,how large can the capital budget be before common stock must be sold?

Question

Quizplus · Accepted Answer

First, we need to find the amount of money the company will retain from the net income:
$30 million x 0.40 = $12 million
This means the company can use $12 million for capital budget without selling any common stock. 
Next, we need to find the total amount of capital budget the company can have without exceeding the 75% equity financing. We can do this by dividing the total capital by 0.75:
Total capital = $12 million / 0.75 = $16 million
Therefore, the capital budget can be as large as $16 million before common stock must be sold. 
The correct choice is (C) $15.5 million, as it is the closest to the calculated amount of $16 million.

Clanton Company Is Financed 75 Percent by Equity and 25