Kendra Brown is analyzing the capital requirements for Reynolds Corporation for
ID: 2710471 • Letter: K
Question
Kendra Brown is analyzing the capital requirements for Reynolds Corporation for next year. Kendra forecasts that Reynolds will need $25 million to fund all of its positive-NPV projects, and her job is to determine how to raise the money. Reynolds’s net income is $16 million, and it has paid a $3 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 40% debt and 60% equity.
Explanation / Answer
Net Income = $16milllion
Dividend to be paid = DPS * no of shares outstanding = 3 * 1 million = $3million
Retained earnings = 16 -3 = $13 million
Funds required = $25 million
Out of $25 million, funds to be raised via equity = 60% * 25 = $15 million
Since retained earnings are a part of equity only $13 million will be come from there itself.
Fresh equity of $2 million will have to be raised.
Funds to be raised via equity = 40% * 25 = $10 million
This $10 million will have to be arranged through issue of new bonds or taking a loan (through debt).
Thus, retained earnings of $13 million along with fresh equity of $2 million and fresh debt of $10 million will be sufficient to fund all the positive NPV projects and maintaining the company's target capital structure.
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