What is the breakpoint due to retained earnings being used up? The K. Wallinger

Question

What is the breakpoint due to retained earnings being used up?

The K. Wallinger Inc. had net income after interest but before taxes of $40,000 this year. The marginal tax rate is 40 percent, and the dividend payout ratio is 30 percent. The company can raise debt at a 12 percent interest rate for any amount of debt less than $8,000. If the firm raises more than $8,000 of debt, a 15 percent rate will apply. The last dividend paid by Wallinger was $0.90. Wallinger's common stock is selling for $8.59 per share, and its expected growth rate in earnings' and dividends is 5 percent. If Wallinger issues new common stock, the notation cost incurred will be 10 percent. Wallinger will have $16,800 available in retained earnings this year. Wallinger plans to finance all capital expenditures with 30 percent debt and 70 percent equity.

Explanation / Answer

Net Income =40,000*(1-taxrate)=40,000*(1-0.40)=24000

Retained Earnings=(1-payout ratio)*Net Income =(1-.30)*24000=16800

breakpoint due to retained earnings being used up

=16800/(1-0.30)

=24000

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