Question

What is the WACC breakpoint formula? A company’s capital structure consists of 25 percent debt and 75 percent common equity. They can issue up to $250,000 in new debt at a 4 percent cost; for new debt greater than $250,000, the cost is 5.5 percent. They expect to generate $600,000 in retained earnings this year. Compute the WACC breakpoint(s) associated with raising new funds. No cost of equity for WACC calculations needed. The breakpoint of retained earnings equals (=) amount of retained earnings divided by the weight of equity.

Answer 1

Debt % in capital structure = 25%

Cost of debt is 4%, if debt is issued up to $250,000

Cost is 5.5% for New debt greater than $250,000.

So, at $250,000 is debt point where cost of funds raised changes..

Break even point formula for raising new funds = Amount of debt point where cost changes / % of Debt

so, WACC break-even point associated with raising new funds = 250,000/25%

=$1,000,000

So, WACC breakeven point associated with raising new funds is $1,000,000.