Question

Warren Supply Inc. is evaluating its capital budget. The company finances with debt and common equity, but because of market conditions, wants to avoid issuing any new common stock during the coming year. It is forecasting an EPS of $3.00 for the coming year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $800,000, and it is committed to maintaining a $2.00 dividend per share. Given these constraints, what percentage of the capital budget must be financed with debt?a. 30.54%b. 32.15%c. 33.84%d. 35.63%

Answer 1

Answer:

37.5%

Explanation:

Given:

Earnings per share, EPS = $3.00

Outstanding shares of stock = 500,000

Capital budget = $800,000

Dividend per share = $2.00

Now,

The  total earning of the Warren Supply Inc. = EPS × Outstanding shares

or

Total earning of the Warren Supply Inc. = $3.00 × 500,000 = $1,500,000

Total Dividends paid = Dividend per share × Outstanding shares

or

Total Dividends paid = $2.00 × 500,000 = $1,000,000

Therefore,

the total retained earnings = Total earning - Total Dividends paid

or

the total retained earnings = $1,500,000 - $1,000,000  = $500,000

Thus,

the capital budget that must be financed with debt

= Forecasted capital budget - Total retained earning

= $800,000 - $500,000

= $300,000

Hence,

the percentage of capital budget that must be financed with debt

=  $\frac{\textup{capital budget that must be financed with debt}}{\textup{Capital budget}}\times100$

on substituting the respective values, we get

= $\frac300000}{800000}\times100$

Percentage of capital budget that must be financed with debt = 37.5%