Question

Sheehan Corp. is forecasting an EPS of $5.00 for the coming year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $700,000, and it is committed to maintaining a $4.00 dividend per share. It finances with debt and common equity, but it wants to avoid issuing any new common stock during the coming year. Given these constraints, what percentage of the capital budget must be financed with debt?

Answer 1

Net income = EPS × Shares outstanding = $5.00 × 500,000 = $2,500,000

Dividends paid = DPS × Shares outstanding = $4.00 × 500,000 = $2,000,000

Retained earnings available = $2,500,000 - $2,000,000 = $500,000

Debt needed = Capital budget - Retained earnings = $700,000 - $500,000 = $200,000

Percentage of the capital budget must be financed with debt = Debt needed/Capital budget = $200,000 / $700,000 = 28.57%