Buena Terra Corporation is reviewing its capital budget forthe upcoming year. It has paid a $3.00 dividend per share (DPS) for the past several years, andits shareholders expect the dividend to remain constant for the next several years. The company’starget capital structure is 60% equity and 40% debt, it has 1,000,000 shares of commonequity 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 dividend model, how much retained earnings willit need to fund its capital budget?b. If Buena Terra follows the residual dividend model, what will be the company’s dividendper share and payout ratio for the upcoming year?c. If Buena Terra maintains its current $3.00 DPS for next year, how much retained earningswill be available for the firm’s capital budget?d. Can the company maintain its current capital structure, the $3.00 DPS, and a $10 millioncapital budget without having to raise new common stock?e. Suppose that Buena Terra’s management is firmly opposed to cutting the dividend; thatis, it wants to maintain the $3.00 dividend for the next year. Also, assume that the company was committed to funding all profitable projects and was willing to issue moredebt (along with the available retained earnings) to help finance the company’s capitalbudget. Assume that the resulting change in capital structure has a minimal effect on thecompany’s composite cost of capital so that the capital budget remains at $10 million.What portion of this year’s capital budget would have to be financed with debt?f. Suppose once again that Buena Terra’s management wants to maintain the $3.00 DPS.In addition, the company wants to maintain its target capital structure (60% equity and40% debt) and its $10 million capital budget. What is the minimum dollar amount ofnew common stock that the company would have to issue to meet each of its objectives?g. Now consider the case where Buena Terra’s management wants to maintain the $3.00DPS and its target capital structure, but it wants to avoid issuing new common stock.The company is willing to cut its capital budget to meet its other objectives. Assumingthat the company’s projects are divisible, what will be the company’s capital budgetfor the next year?h. What actions can a firm that follows the residual dividend model take when its forecastedretained earnings are less than the retained earnings required to fund its capital budget?
Master Budget
A master budget can be defined as an estimation of the revenue earned or expenses incurred over a specified period of time in the future and it is generally prepared on a periodic basis which can be either monthly, quarterly, half-yearly, or annually. It helps a business, an organization, or even an individual to manage the money effectively. A budget also helps in monitoring the performance of the people in the organization and helps in better decision-making.
Sales Budget and Selling
A budget is a financial plan designed by an undertaking for a definite period in future which acts as a major contributor towards enhancing the financial success of the business undertaking. The budget generally takes into account both current and future income and expenses.
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% equity and 40% debt, it has 1,000,000 shares of common
equity outstanding, and its net income is $8 million. The company
$10 million to fund all of its profitable (i.e., positive
a. If Buena Terra follows the residual dividend model, how much
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, the $3.00 DPS, and a $10 million
capital budget without having to raise new common stock?
e. Suppose that Buena Terra’s management is firmly opposed to cutting the dividend; that
is, it wants to maintain the $3.00 dividend for the next year. Also, assume that the company was committed to funding all profitable projects and was willing to issue more
debt (along with the available retained earnings) to help finance the company’s capital
budget. Assume that the resulting change in capital structure has a minimal effect on the
company’s composite cost of capital so that the capital budget remains at $10 million.
What portion of this year’s capital budget would have to be financed with debt?
f. Suppose once again that Buena Terra’s management wants to maintain the $3.00 DPS.
In addition, the company wants to maintain its target capital structure (60% equity and
40% debt) and its $10 million capital budget. What is the minimum dollar amount of
new common stock that the company would have to issue to meet each of its objectives?
g. Now consider the case where Buena Terra’s management wants to maintain the $3.00
DPS and its target capital structure, but it wants to avoid issuing new common stock.
The company is willing to cut its capital budget to meet its other objectives. Assuming
that the company’s projects are divisible, what will be the company’s capital budget
for the next year?
h. What actions can a firm that follows the residual dividend model take when its forecasted
retained earnings are less than the retained earnings required to fund its capital budget?
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