Buena Terra Corporation is reviewing its capital budget for the upcoming year. It has paid a $3.00

QUESTION

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 would require $10
million to fund all of its profitable (that is, positive NPV) projects for the upcoming year.

a. If Buena Terra follows the residual dividend model, how much retained earnings will it need to fund its capital budget?

b. If Buena Terra follows the residual dividend model, what will be the company”s dividend per share and payout ratio for the upcoming year?

c. If Buena Terra maintains its current $3.00 DPS for next year, how much retained earnings will be available for the firm”s capital 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?

ANSWER:

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