A firm's correctly computed capital structure is 30% debt, 20% preferred stock, and 50% equity. If retained earnings of $1 million are expected, how much capital will have been raised when retained earnings are exhausted and new common equity must be issued?

Question

Quizplus · Accepted Answer

Total capital raised = retained earnings / (1 - % of equity)
Total capital raised = $1,000,000 / (1 - 50%) = $2,000,000
Since the question only asks for the amount of new common equity, we need to subtract the amount of debt and preferred stock from the total capital raised:
New common equity = total capital raised - debt - preferred stock
New common equity = $2,000,000 - 30%($2,000,000) - 20%($2,000,000) = $1,428,571

A Firm's Correctly Computed Capital Structure Is 30% Debt, 20