Leon Inc. has the following capital structure, which it considers to be optimal: Debt 25% Preferred...
Leon Inc. has the following capital structure, which it considers to be optimal:
| Debt | 25% |
| Preferred Stock | 15% |
| Common Equity | 60% |
Leon’s expected net income this year is $34,285.72, its established dividend payout ratio is 30%, its federal-plus-state tax rate is 25%, and investors expect future earnings and dividends to grow at a constant rate of 9%. Leon paid a dividend of $3.60 per share last year, and its stock currently sells for $54.00 per share. Leon can obtain new capital in the following ways:
1. New preferred stock with a dividend of $11.00 can be sold to the public at a price of $95.00 per share.
2. Debt can be sold at an interest rate of 12%.
| Project | Cost at t=0 | Rate of Return |
|---|---|---|
| A | $10,000 | 17.4% |
| B | $20,000 | 16% |
| C | $10,000 | 14.2% |
| D | $20,000 | 13.2% |
| E | $10,000 | 12% |
Calculate the Retained earnings breakpoint. Assume that Leon does not want to issue any new common stock.
Homework Answers
Retained earnings breakpoint = addition to retained earnings/weight of equity in the capital structure
Addition to retained earnings = (1-payout ratio)*net income = (1-30%)*34,285.72 = 24,000.00
Retained earnings break-point = 24,000/60% = 40,000.01
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