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 35% debt, 10% preferred stock and 55% 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 $28 per share. Last year's dividend was $1.50 per share. The growth rate is 8%. The company's preferred stock is selling at $45 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 6%, but its investment banker has informed the company that interest rates for bonds of equal risk are currently yielding 5%. Zinger's tax rate is 40%. PLEASE SHOW YOUR WORK.
a) Compute the cost of debt (Kd,)
b) Compute the cost of preferred stock (Kp,)
c) Compute the cost of retained earnings (Ke, )
d) Compute the cost of equity assuming the company issues new common stock (Kn.)
e) Calculate the initial weighted average cost of capital using Ke.
f) How large a capital budget can the firm support with retained earnings financing?