Question
IMEP 522 Spring 2016 5 FPI) is planning next year's capital budget. FPI at $7.500, and its payout ratio is 40 percent The projects its net income earnings and dividends are growing at constant rate of 5 percent the last dividend paid, D0, was S0.90; and the current stock prioe is $8.59. FPIs new debt will oost 14 percent. If FPI issues new common stock. fotation 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 $15,000 20.000 16 12,000 What is FPI's optimal capital budget? Reteamings breakpoint Debt breakpoints No Debt breakpoints Above break 1 e Project cost RR Cum cost Dalbudget 4 20 000 140 cts can be mested because
Explanation / Answer
Net Income 7500 Payout 0.4 1 - payout 0.6 Retained earnings 4500 % equity 0.6 Retained earnings break point 7500 Debt break points No debt breakpoints Rs D0 0.9 1+g 1.05 D1 0.945 P0 8.59 D1/P0 0.1100 g 0.05 Rs 0.1600 Re D1 0.945 F 0.2 P0(1-F) 6.872 D1/P0(1-F) 0.1375 g 0.05 Re 0.1875 WACC 1-T After tax Weight WACC Below break point Rdt 14.00 0.6 8.4 0.4 3.36 Rs 16.00 1.0 16.00 0.6 9.60 WACC 12.96 Above breakpoint Rdt 14.00 0.6 8.4 0.4 3.36 Re 18.75 1.0 18.75 0.6 11.25 14.61 Project Cost IRR Cum cost total budget 42000 1 15000 17 15000 % debt 0.4 2 15000 16 30000 Debt 16800 3 12000 15 42000 Equity 25200 4 20000 14 62000 Projects #1,2 & 3 can be invested because its IRR > WACC above breakpoint. Project #4 cannot be invested because its IRR