Clanton Company is financed 75 percent by equity and 25 percent by debt. If the firm expects to earn $30 million in net income next year and retain 40% of it, how large can the capital budget be before common stock must be sold?
15.5 million
To determine the size of the capital budget before common stock must be sold, we need to use the concept of the sustainable growth rate (SGR). The SGR represents the maximum growth a company can achieve without having to issue new equity.
To calculate the SGR, we need two pieces of information: the retention ratio (the proportion of net income retained) and the return on equity (ROE) which represents the profitability of the company.
Given that Clanton Company retains 40% of its net income, this means the retention ratio (RR) is 0.40. However, we still need the return on equity (ROE) in order to proceed. The problem statement doesn't provide this information, so we cannot calculate the SGR accurately.
ROE can be determined in several ways, such as using the DuPont formula which breaks down the ROE into its individual components. It typically includes the profit margin, asset turnover, and financial leverage. Without this information, we cannot calculate the SGR and determine the capital budget size before common stock must be sold.
Therefore, to answer your question accurately, we need additional information about the return on equity (ROE) for Clanton Company.