Answer to Question #12663 in Management for John

Question

1. Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?
a. Increase the dividend payout ratio for the upcoming year.
b. Increase the percentage of debt in the target capital structure.
c. Increase the proposed capital budget.
d. Reduce the amount of short-term bank debt in order to increase the current ratio.
e. Reduce the percentage of debt in the target capital structure.

Answer 1

Answer is: b (Increase the percentage debt in the target capital structure)

The increase of percentage debt in the target capital structure will automatically reduce the equity capital and the budget, so there will be no need in issuing additional common stock in order to distribute the earnings.