Question

Question 25 (4 points) Marginal Incorporated (MI) has determined that its after-tax cost of debt is 5.0% for the first $62 million in bonds it issues, and 7.0% for any bonds issued above $62 million. Its cost of preferred stock is 12.0%. Its cost of internal equity is 15.0%, and its cost of external equity is 19.0%. Currently, the firm's capital structure has $325 million of debt, $70 million of preferred stock, and $105 million of common equity. The firm's marginal tax rate is 45%. The firm's managers have determined that the firm should have $50 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 $167 million? 8.08% 10.22% 9.38% 8.92% 8.17% 7.33% 6.62% 7.46%

Answer 1

Capital Budget = $167 million

To be financed through:

Debt = 167*325/500 = 108.55 million

Preferred Stock = 23.38 million

Equity = 35.07 million

Hence, Retained earnings are sufficient to meet requirement for equity.

Marginal cost of capital is equal to the cost of additional Dollar of capital raised

= 7%*325/500 + 12%*70/500+ 15%*105/500

= 9.38%