Question

An analyst gathers the following information about the cost and availability of

         raising various amounts of new debt and equity capital for a company:

Amount of new debt (in millions)	Cost of debt (after tax)		Amount of new equity (in millions)	Cost of equity
≤ €4.0 > €4.0	4% 5%		≤ €5.0 > €5.0	13% 15%

The company’s target capital structure is 60 percent equity and 40 percent debt. If the company raises €9.5 million in new financing, the marginal cost of capital is closest to:

A. 9.8%.

B. 10.6%.

C. 11.0%.

D. 11.7%

Answer 1

First we have to find out the break even points for debt and equity

Break even point for Debt = 4 mil / Target debt percent

= 4 mil / 0.4

= 10 mil

Break even point for Equity = 5 mil / Target equity percent

= 5 mil / 0.6

= 8.33 mil

Now the company raises 9.5 mil in new financing

9.5 mil is below the Debt break even point , so cost of debt(after tax) = 4%

9.5 mil is above the Equity break even point , so cost of equity = 15%

The WACC or marginal cost of capital = weight of debt * after tax cost of debt + weight of equity * cost of equity

= 0.4 * 4 + 0.6*15

= 10.6 %

B) 10.6 %