Andrews Corporation plans a $10 million expansion. The firm wants to maintain a
ID: 2634380 • Letter: A
Question
Andrews Corporation plans a $10 million expansion. The firm wants to maintain a 45 percent debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 30 percent of last year's net income. Last year, net income was $4 million.
1) Calculate the amount of external equity needed. (I have calculated this to be 2.7 million)
2) If the company changed to a residual dividend policy, how much external equity will it need?
3) Is the company likely to change to a residual policy? Why or why not?
Explanation / Answer
1) Calculate the amount of external equity needed.
Last year's net income = $4 million
Dividends = $4 million x 0.3 = 1.2 million
Income left after dividends = $4 million - 1.2 Million = 2.8 million
Equity needed = 10 millino project - 2.8 million after dividends = 7.2 million financing needed
2) If the company changed to a residual dividend policy, how much external equity will it need?
With a residual dividend policy, no dividends would be paid that year.
$10 million - $4 million = 6 million financing needed.
3) Is the company likely to change to a residual policy? Why or why not?
I doubt they would change to a residual policy. Most companies do not make such a change based on a single project. If they do, it will likely cause the stock price to go down which in turn will lower the amount of equity and assets. This would throw the ratio even more out of wack.