Question

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%

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.