Question

Zinger Corporation manufactures industrial type sewing machines. Zinger Corp. received a very large order from a few European countries. In order to be able to supply these countries with its products, Zinger will have to expand its facilities. Of the required expansion, Zinger feels it can raise $75 million internally, through retained earnings. The firm's optimum capital structure has been 45% debt, 10% preferred stock, and 45% equity. The company will try to maintain this capital structure in financing this expansion plan. Currently Zinger's common stock is traded at a price of $20 per share. Last year's dividend was $1.50 per share. The growth rate has been at 6% and is expected to increase to 8%. The company's preferred stock is selling at $50 and has been yielding 6% in the current market. Flotation costs have been estimated at 8% of common stock and 3% of preferred stock. Zinger Corp. has bonds outstanding at 10%, but its investment dealer has informed the company that interest rates for bonds of equal risk are currently yielding 9%. Zinger's tax rate is 46%.

A) Compute the cost of Kd, Kp, Ke, Kn.

B) Calculate the weighted average cost of capital, assuming no external equity financing.

C) How much can Zinger raise to fund the whole project, while using only internal financing?

Answer 1

A)	Cost of debt = Before tax cost of debt*(1-t) = 9%*(1-46%) =	4.86%
	Cost of preferred stock = 3/(50*97%) =	6.19%
	[Preferred dividend = $50*6% = $3]
	Cost of retained earnings using Constant DDM = 1.50*1.08/20+0.08 =	16.10%
	Cost of new common equity = 1.50*1.08/(20*92%)+0.08 =	16.80%
B)	WACC = 4.86%*45%+6.19%*10%+16.10%*45% =	10.05%
C)	If only internal financing is used $75 million/45% =	$        166.67	million