Question

In: Finance

Giovanni Corp.’s projected net income is $375.0 million, its target capital structure is 30% debt and...

Giovanni Corp.’s projected net income is $375.0 million, its target capital structure is 30% debt and 70% equity, and its target payout ratio is 35%. Giovanni has more positive NPV projects than it can finance without issuing new stock, but its board of directors had decreed that it cannot issue any new shares in the foreseeable future. The CFO now wants to determine how the maximum capital budget would be affected by changes in the capital structure policy and/or the target dividend payout policy. Versus the current policy, how much larger could the capital budget be if (1) the target debt ratio were raised to 70%, other things held constant, (2) the target payout ratio were lowered to 15%, other things held constant, and (3) the debt ratio and payout were both changed by the indicated amounts

(1) 464.29

(2) 107.14

(3) 714.29

(1) 460.29

(2) 111.14

(3) 718.29

(1) 469.69

(2) 103.23

(3) 709.69

(1) 451.69

(2) 114.23

(3) 702.69

Solutions

Expert Solution

Payout ratio = Dividends/Net Income

So Dividends = Net Income *payout = 375*0.35 = 131.25

Equity = Net Income – Dividends = 375 – 131.25 = 243.75

Capital budget = Equity/Equity ratio = 243.75/0.70 = 348.21

(1)

If target ratio raised for debt to 70%, then Equity is 30%

Capital budget = Equity/Equity ratio = 243.75/0.30 = 812.5

Change = 813.5 – 348.21 = $464.29

answer: 464.29

(2)

If target payout lowered to 15%

So Dividends = Net Income *payout = 375*0.15 = 56.25

Equity = Net Income – Dividends = 375 – 56.25 = 318.75

Capital budget = Equity/Equity ratio = 318.75/0.70 = 455.35

Change = 455.35 - 348.21 = $107.14

answer: 107.14

(3)

If target payout lowered to 15%

So Dividends = Net Income *payout = 375*0.15 = 56.25

Equity = Net Income – Dividends = 375 – 56.25 = 318.75

If target ratio raised for debt to 70%, then Equity is 30%

Capital budget = Equity/Equity ratio = 318.75/0.30 = 1062.5

Change = 1062.5– 348.21 = $714.29

answer: $714.29

Note: dollar values/amounts are in million

jeff jeffy answered 1 year ago

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