Question

A company plans to expand its operation by 25% by spending $5,000,000 for an additional building. They would like to maintain its 40% debt to asset ratio in its capital structure and its dividend payout ratio of 50% of net income. Last year, net income was $2,500,000.

1. What are retained earnings for the last year?
2. How much debt will be needed for the new project?
3. How much external equity must the company use at the beginning of this year in order to finance the new expansion?
4. If the company decides to retain all earnings for the coming year, how much external equity will be required?

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Given that:

Investment needed $5.000.000
Debt to asset ratio 40%
Dividend payout ratio 50%
Net income $2.500.000

Answer 1:

Retained earnings = (1 - Dividend payout ratio) * Net income
Here it is $1.250.000 ...

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