XXX Inc predicts that earnings in the coming year will be $54 million. There are

Question

XXX Inc predicts that earnings in the coming year will be $54 million. There are 19 million shares, and PR maintains a debt-equity ratio of 1.2.

Calculate the maximum investment funds available without issuing new equity and the increase in borrowing that goes along with it.

Suppose the firm uses a residual dividend policy. Planned capital expenditures total $74 million. Based on this information, what will the dividend per share be?

In part (b), how much borrowing will take place? What is the addition to retained earnings?

Explanation / Answer

Earnings is calculated after the payment of interest on existing borrowings, so we can assume that whole earnings at the maximum can be available for investment funds.

So , Equity contribution to growth of firm = $ 54 m

Accordingly , Debt contribution = 54 * 1.2 = $ 64.8 m

Residual dividend policy states that , after paying all the positive NPV projects whatever is the leftover from the earnings , is available to be distributed in dividend.

Planned captial expenditure = $ 74 m

For $74 m , Debt contribution = 1.2 /2.2 * 74 = $40.36 m ( This amount is borrowed )

similarly Equity contribution = 74 - 40.36 = $33.64 m ( This is added to the retained earnings )

Left over Earnings = 54 - 33.64 = $20.36 m

Number of shares = 19 m

Dividend per share = 20.36/19 = $ 1.07

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