Perfect Pet Food, Inc., is a premier manufacturer of both canned and dry food for cats and
Question:
Perfect Pet Food, Inc., is a premier manufacturer of both canned and dry food for cats and dogs of all ages and breeds.Located in Kansas City, Kansas, the firm has recently expanded its service area to include the entire continental United States.To meet the growing demand for its products, the firm is planning to build two product warehouses at a cost of $4 million each, for a total capital budget for the coming year of $8 million.
Perfect Pet Food, Inc. currently has a capital structure that consists of 80 percent equity and 20 percent debt, as the firm's shareholders are quite risk averse.The firm's "Net Income" for the coming year is expected to be $7.5 million.Perfect Pet Food uses the Residual Dividend Model, with all distributions to shareholders made in the form of dividends.
Given this information, please answer the following questions:
1.Based on Perfect Pet Food's current capital structure, how much equity capital is needed for the firm's projected $8 million capital budget to fund the two product warehouses?
2.How much of Perfect Pet Foods "Net Income" will remain to be used for dividends to the firm's shareholders, after deducting the equity capital needed to fund the warehouses that you calculated in Question #1?
3.Using the funds available for dividends to the firm's shareholders that you calculated in Question #2 above, calculate Perfect Pet Food's dividend payout ratio expected during the coming year.
4.Now assume that Perfect Pet Food alters its target capital structure to 60 percent equity and 40 percent debt for the coming year.Based on this new capital structure, please answer the following questions:
a.How much equity capital will now be needed to fund the firm's projected $8 million capital budget for the two warehouses?
b.How much of Perfect Pet Food's "Net Income" will now remain to be used for dividends to the firm's shareholders after deducting the equity capital needed to fund the warehouses that you calculated in Question #4.a. above?
c.Using the funds available for dividends to the firm's shareholders that you calculated in
Question #4.b. above, calculate Perfect Pet Food's dividend payout ratio expected
during the coming year with the proposed 60% equity/40% debt capital structure.
5.Do you recommend that Perfect Pet Food alter its capital structure from 80% equity/20% debt to 60% equity/40% debt?Why or why not?