The management of Frrei Phos Ind (FPI) it planning next year\'s capital budget F
ID: 2738822 • Letter: T
Question
The management of Frrei Phos Ind (FPI) it planning next year's capital budget FPI projects its net income at $7,500. end its payout ratio is 40 percent The Company s earnings and dividends are growing at a constant rata of 5 percent, the last dividend paid D0. was $0 90. and the current stock price is$8 59 FPI's new debt will cost 14 percent If FPI issues new common stock flotation costs will be 20 percent FPI is at its optimal capital structure, which is 40 percent debt and 60 percent equity, and the firm's marginal tax rate is 40 percent FPI has the following independent indivisible, and equally risky investment opportunities:Explanation / Answer
Cost of equity = [Expected dividend / Price of stock] + Growth rate
(Expected dividend = 0.90 + 5% = $ 0.945, Growth rate = 0.05 and Price of stock = 8.59 - 20% of 8.59 = $ 6.872)
Thus, Cost of equity = 0.945 / 6.872 + 0.05
= 0.1375 + 0.05
= 0.1875 i.e., 18.75 %
Cost of debt = 14 * (1 - 0.40) = 8.4 %
Weighted average cost of capital (WACC) = Weight of equity * Cost of equity + Weight of debt * Cost of debt
= 0.60 * 18.75 + 0.40 * 8.4
= 14.61 % (approx)
Project A, Project C and Project D have IRR greater than the Weighted average cost of capital (WACC), Hence these projects are acceptable. Thus, the FPI's optimal capital budget = 15000 + 15000 + 12000 = $ 42000.
Conclusion:- The FPI's optimal capital budget = $ 42000.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.