Question

Question 24 (4 points) Marginal Incorporated (MI) has determined that its before-tax cost of debt is 7.0 % Its cost of preferred stock is 14.0 %. Its cost of internal equity is 16.0%, and its cost of external equity is 21.0%. Currently, the firm's capital structure has $621 million of debt, $45 million of preferred stock, and $234 million of common equity. The firm's marginal tax rate is 25%. The firm is currently making projections for the next period. Its managers have determined that the firm should have $99 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 $270 million? 8.48% 9.78% 9.13% 10.99% 9.69%

Answer 1

Marginal cost of capital is the cost of capital for one additional dollar raised

Capital Budget = $270 million

To be financed through Equity = 270 million*234/900 = 70.2 million

Available from retained earnings = $99 million

Hence, no external equity will be required

WACC = Cost of debt*Weight of Debt + Cost of Preferred Stock*Weight of Preferred Stock + Cost of Equity*Weight of Equity

= 7%(1-25%)*621/900 + 14%*45/900 + 16%*234/900

=8.4825%

i.e. 8.48%