Question

Compuvac Company just completed its initial forecasts of next year's financial statements using the projected balance sheet method. The firm determined that it needs $4 million in new debt, which can be issued at par with a 10 percent annual coupon. Additionally, the firm can sell 500,000 shares of new common equity, which will net $18.10 per share. Next year's expected dividend is $0.48 per share. After accounting for the financing feedbacks associated with raising the required funds, Compuvac expects its taxes to be $160,000 lower than were reported in the initial forecasts. Given this information, what should Compuvac find the change to be in the addition to retained earnings that is reported in the income statement that was initially forecasted after the financing feedbacks are included

Answer 1

$4 million in new debt at 10% annual coupon

500,000 shares x $18.10

new year's expected dividend = $0.48

taxes will decrease by $160,000

Compuvac will need to pay $4,000,000 x 10% = $400,000 in interests for the bonds that it plans to issue new year. That is why their taxes will decrease by $160,000 = total debt payments x tax rate = $400,000 x 40%

It will also need to pay $0.48 x 500,000 shares = $240,000 in additional dividends.

The increase in additional funds needed (AFN) = total interest paid for the bonds - less taxes + additional dividends = $400,000 - $160,000 + $240,000 = $480,000