The management of Ferri Phosphate Industries (FPI) is planning next year's capital budget. FPI projects its net income at $7,500, and its payout ratio is 40 percent The company's earnings and...

The management of Ferri Phosphate Industries (FPI) is planning next year's capital budget. FPI
projects its net income at $7,500, and its payout ratio is 40 percent The company's earnings and
dividends are growing at a constant rate of 5 percent; the last dividend paid, D0, was $0.90; and
the cu rrent stock price is $859. 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:


What is FPI's optimal capital budget?
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Solution:
Target structure:
Debt = 40%
Equity = 1 – 40% = 60%
Equity includes both retained earnings and new issuance of common stock.
Net income = $7,500
Payout ratio = 40%
Retention ratio = 1-40% = 60%
Retained earnings = $7,500*60% = $4,500
Any excess equity capital investment required will be raised through new tock issue.
Cost of capital:
Cost of equity (retained earnigs), Ke = D0*(1+g) / P0 + g...