Wolverine Corporation plans to pay a $3 dividend per share on each of its 300,00

Question

Wolverine Corporation plans to pay a $3 dividend per share on each of its 300,000 shares next year. Wolverine anticipates earnings of $6.25 per share over the year. If the company has a capital budget requiring an investment of $4 million over the year and it desires to maintain its present debt to total assets (debt ratio) of 0.40, how much external equity must it raise? Assume that Wolverines capital structure includes only common equity and debt, and that debt and equity will be the only sources of funds to finance capital projects over the year.

Explanation / Answer

Retention for coming year:

$6.25 - $3.00 = $3.25/share

300,000 shares x $3.25/share = $975,000 total retained    equity for year

Equity portion of capital budget requirements:

=0.60($4,000,000) = $2,400,000

External equity needed: $2,400,000 - 975,000 = $1,425,000

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