Question

50) Marginal Incorporated (MI) has determined that its after-tax cost of debt is 5.0% for the...

50) Marginal Incorporated (MI) has determined that its after-tax cost of debt is 5.0% for the first $74 million in bonds it issues, and 9.0% for any bonds issued above $74 million. Its cost of preferred stock is 15.0%. Its cost of internal equity is 18.0%, and its cost of external equity is 22.0%. Currently, the firm's capital structure has $400 million of debt, $60 million of preferred stock, and $540 million of common equity. The firm's marginal tax rate is 25%. The firm's managers have determined that the firm should have $67 million available from retained earnings for investment purposes next period. What is the firm's marginal cost of capital at a total investment level of $260 million?

14.22%
14.78%
12.62%
16.38%
15.48%
14.28%
12.12%
13.32%

Homework Answers

Answer #1
Value Weight
Debt 400 40%
Preferred 60 6%
Equity 540 54%
Total 1000

Total Investment = 260

=> Debt Required = 40% x 260 = 104, Preferred stock = 6% x 260 = 15.6 and common equity = 54% x 260 = 140.4

Value Weight Cost
Debt 1 74 28% 5%
Debt 2 30 12% 9%
Preferred 15.6 6% 15%
Retained 67 26% 18%
New equity 73.4 28% 22%
Total 260 MCC 14.21%

Now, off the total debt required, cost is 5% upto 74 million and beyond which it is 9%.

Similarly, of the total equity, 67 million is available from retained earnings and balance from new equity

Marginal Cost of capital (MCC) = sum of weight x cost = 14.21%

Hence, the first option is the closest.

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