Brock Brothers wants to maintain its capital structure that is 30 percent debt, and 70 percent equity. The company forecasts that its net income this year will be $1,000,000. The company follows a residual distribution policy (with all distributions in the form of dividends), and anticipates a dividend payout ratio of 40 percent. What is the size of the company's capital budget?
A) $ 600,000
B) $ 857,143
C) $1,000,000
D) $1,428,571
E) $2,000,000

Question

Quizplus · Accepted Answer

First, we need to calculate the amount of dividends that will be paid out:

Dividends = Net Income x Dividend Payout Ratio
Dividends = $1,000,000 x 0.40
Dividends = $400,000

Next, we need to calculate the amount of equity that will be required to maintain the 70 percent equity portion of the capital structure:

Equity Required = Total Capital x Equity Percentage
Equity Required = (Total Capital - Debt) x 0.70
Equity Required = ($1,428,571 - $1,000,000) x 0.70
Equity Required = $299,999.70 (rounded)

Finally, we can calculate the size of the capital budget:

Capital Budget = Equity Required + Dividends
Capital Budget = $299,999.70 + $400,000
Capital Budget = $699,999.70 (rounded)

Therefore, the best choice is B, $857,143.

Brock Brothers Wants to Maintain Its Capital Structure That Is