Question

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 proposed capital budget.
B. Reduce the amount of short-term bank debt in order to increase the current ratio.
C. Increase the dividend payout ratio for the upcoming year.
D. Reduce the percentage of debt in the target capital structure.
E. Increase the percentage of debt in the target capital structure.

Answer 1

Answer: Option (E) is correct.

From the given option, the following will reduce Bankston's need to issue new common stock: Increase the percentage of debt in the target capital structure.

With an increase in percentage of debt , there will be a proportional increase in cost of equity and thereby decreasing investment in equity. This will therefore reduce Bankston's need to issue new common stock