Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $3.00 dividend
per share (DPS) for the past several years, and its shareholders expect the dividend to remain constant for the
next several years. The company's target capital structure is 60 percent equity and 40 percent debt. It has
1,000,000 shares of common equity outstanding, and its net income is $8 million. The company forecasts that it
will require $10 million to fund all of its profitable (i.e., positive NPV) projects for the upcoming year.
a. If Buena Terra follows the residual distribution model (and makes all distributions as
dividends), how much retained earnings will it need to fund its capital budget?
Input Data
Dividend per share $3.00
Target equity ratio 60%
Target debt ratio 40%
Shares outstanding 1,000,000
Net Income $8,000,000
Total capital budget $10,000,000
Required retained earnings = Total capital budget x Target equity ratio
Required retained earnings =
Required retained earnings =
b. If Buena Terra follows the residual model with all distributions in the form of dividends, what
will the company's dividend per share and payout ratio be for the upcoming year?
Dividend per share = (Net Income - Required RE) / Shares outstanding
Dividend per share =
Dividend per share = So, following the residual policy would require a dividend cut.
Dividend payout ratio = Dividend paid / Net Income
Dividend payout ratio =
Dividend payout ratio =
c. If Buena Terra maintains its current $3.00 DPS for next year, how much retained earnings would be
available to support the capital budget?
Desired DPS = $3.00
Retained earnings for cap. budget = Net Income - DPS x # of shares
Retained earnings for cap. budget =
Retained earnings for cap. budget =
d. Can the company maintain its current capital structure, maintain the $3.00 DPS, and maintain a $10
million capital budget without having to raise new common stock?
e. Suppose that Buena Terra's board is firmly opposed to cutting the dividend, that is, insists on maintaining
the $3.00 dividend. Also, assume that the company is committed to funding all profitable projects and is
willing to issue more debt (along with the available retained earnings) to help finance the capital budget.
Assume that the resulting change in capital structure has a minimal impact on the company's composite cost of
capital, so that the capital budget remains at $10 million. What % of this year's capital budget would have to
be financed with debt?
DPS $3.00
Total capital budget $10,000,000
Dividends paid = DPS x # of shares
Dividends paid =
Dividends paid =
RE Available = Net Income - Dividends paid
RE Available =
RE Available =
Portion of cap. budget from equity = RE to be used / Total capital budget
Portion of cap. budget from equity =
Portion of cap. budget from equity =
Portion of cap. budget from debt = - Portion of cap. budget from equity
Portion of cap. budget from debt =
f. Suppose once again that Buena Terra's management wants to maintain the $3.00 DPS. It also wants to
maintain its target capital structure (60 percent equity, 40 percent debt) and to finance a $10 million capital
budget. What is the minimum dollar amount of new common stock that must be issued to meet these
objectives?
g. Now suppose Buena Terra's management wants to maintain the $3.00 DPS and its target capital structure,
but it does not want to issue new common stock. Management is willing to cut the capital budget to meet
these objectives. Assuming the projects are divisible, what will the company's capital budget be for the next
year?
Total capital budget = Available RE / Target Equity ratio
=
Total capital budget =
DIVIDEND INCOME CALCULATOR
INPUT DATA
Stock #1:[Enter Name] Stock #2:[Enter Name] Stock #3:[Enter Name]
# of Shares 100 # of Shares - # of Shares 5,000
Price of Shares $ 50.00 Price of Shares $ - Price of Shares $ 44.00
Total Investment $ 5,000.00 Total Investment $ - Total Investment $ 220,000.00
Dividend Yield 5% Dividend Yield 0% Dividend Yield 4%
Dividend Growth Rate 5% Dividend Growth Rate 0% Dividend Growth Rate 3%
AUTO CALCULATION (Do Not Edit)
Stock # 1 Dividend Income Stock #2 Dividend Income Stock #3 Dividend Income
Year Reinvested Not Reinvested Reinvested Not Reinvested Reinvested Not Reinvested
1 $ 250.00 $ 250.00 $ - $ - $ 8,800.00 $ 8,800.00
2 $ 275.63 $