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Marginal cost of capital schedule

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Owen's enterprises is in the process of determining its capital budget for the next
fiscal year. The firms current capital structure, which it considers to be optimal, is
contained in the following balance sheet.

Balance Sheet
Current Assets $40,000,000 Accounts Payable $20,000,000
Fixed Assets 400,000,000 Other Current Liabilities 10,000,000
Total Assets $440,000,000 Long term debt 123,000,000
Common Stock at par 15,000,000.00
Paid in capital in excess of par 51,000,000
retained earnings 220,500,000
Total Liabilities and
stockholders equity $440,000,000

The following information has been obtained from conversations with financial officers, and the firms investment
banker and lead bank

?The firm expects net income from this year to total $80 million. The firm intends to maintain its dividend
policy of paying 42.25 percent of earnings to stock holders

?The firm can borrow $18 million from its bank at a 13 percent annual rate

?any additional debt can be obtained through the issuance of debentures (at par) that carry
a 15 percent coupon rate

?The firm currently pays $4.40 per share in dividends (Do). Dividends have grown at a 5% rate in the
past. This growth is expected to continue

?The firm's common stock currently trades at $4 per share. If the firm were to raise any external equity
the newly issued shares would net the company $40 per share

?The firm is in the 40% marginal tax bracket.

Computes Owens marginal cost of capital schedule.

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Solution Preview

In marginal cost of capital schedule, we find the total capital that can be raised at various cost of capital.
In this problem, the given capital structure is optimal. So we first find the optimal capital structure

Long term debt 123,000,000
Common Stock at par 15,000,000.00
Paid in capital in excess of par 51,000,000
retained ...

Solution Summary

The solution explains how to compute the marginal cost of capital schedule

$2.19
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Marginal cost of capital (WACC) above and below the break points in the MCC:
A company has been growing at a constant rate of 8% a year. Its retained earnings for the year are $16 million, common stock is selling for $60, and the current debt to assets ratio is 35%. The company can raise up to $18 million in debt at 8%. A 12% interest will apply if the amount exceeds $18 million. New common stock yields the firm $45. The required rate of return on retained earnings is 12%.The tax rate is 40%. Calculate the marginal cost of capital (WACC) above and below the break points in the MCC schedule.

A company has been growing at a constant rate of 8% a year. Its retained earnings for the year are $16 million, common stock is selling for $60, and the current debt to assets ratio is 35%. The company can raise up to $18 million in debt at 8%. A 12% interest will apply if the amount exceeds $18 million. New common stock yields the firm $45. The required rate of return on retained earnings is 12%.The tax rate is 40%. Calculate the marginal cost of capital (WACC) above and below the break points in the MCC schedule.

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