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Finance: Weighted average cost of capital

ADB Corporation is considering building a new facility in Texas. To raise money for the capital projects,
the corporation plans the following capital structure: 30% of money will come from issuing bonds,
and 70% will come from Retained Earnings or new common stock.

The corporation does not currently have preferred stock. ADB Corporation will issue bonds with an interest rate of 8%
up to $30 million dollars in bonds. After issuing $30 million in bonds, the interest cost will rise to 12.5%.

The next dividend on common stock is expected to be $2.00 per share. The stock price is $25.00 per share, and is expected
to grow at 3% per year. The flotation cost for issuing new common stock is estimated at 10%.

ADB Corporation has $66 million in retained earnings that can be used.

The tax rate for ADB Corporation is 35%.

1. What is the initial weighed average cost of capital (WACC) for ADB Corporation?

2. There are two breakpoints in ADB's capital structure. At what point does the first breakpoint occur?

Solution Summary

The problem deals with determining the cost of capital with provided information.