Question

Beranek Corp has $695,000 of assets (which equal total invested capital), and it uses no debt - it is financed only with common equity. The new CFO wants to employ enough debt to raise the total debt to total capital ratio to 40%, using the proceeds from borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?

Answer 1

$278,000

Step-by-step explanation:

Data provided:

Total invested capital or assets = $695,000

Total debt to total capital ratio = 40%

now,

`\frac{\textup{Total debt}}{\textup{Total capital}}` =
`\frac{\textup{40}}{\textup{100}}`

or

Total debt = 0.4 × Total capital

or

Total debt = 0.4 × $695,000

or

Total debt = $278,000

Hence,

The firm must borrow $278,000 to achieve the desired ratio