The Nolan Corporation finds that it is necessary to determine its marginal cost

Question

The Nolan Corporation finds that it is necessary to determine its marginal cost of capital. Nolans current capital structure calls for 30 percent debt, 20 percent preferred stock, and 50 percent common equity. Initially common equity will be in the form of retained earnings (Ke) and then new common stock (Kn). The costs of the various sources of financing are as follows: debt, 9.2 percent; preferred stock, 8 percent; retained earning, 9 percent; and new common stock, 10.2 percent.

(a) What is the initial weighted average cost of capital? (Round your intermediate calculations and final answer to 2 decimal places. Omit the "%" sign in your response.) Weighted average cost of capital %

(b) If the firm has $31 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions. Omit the "$" sign in your response.) Capital structure size (X) $ million

(c) What will the marginal cost of capital be immediately after that point? (Equity will remain at 50 percent of the capital structure, but will all be in the form of new common stock, Kn.)(Round your intermediate calculations and final answer to 2 decimal places. Omit the "%" sign in your response.) Marginal cost of capital %

(d) The 9.2 percent cost of debt referred to above applies only to the first $9 million of debt. After that the cost of debt will be 11.2 percent. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions. Omit the "$" sign in your response.) Capital structure size (Z) $ million

(e) What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts c and d.) (Round your intermediate calculations and final answer to 2 decimal places. Omit the "%" sign in your response.) Marginal cost of capital %

Explanation / Answer

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Solution Problem 11-26 (LO 3, LO 5) Instructions Using the facts from the problem, enter formulas to solve the requirements of the problem.. a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings.) Cost Weighted (after tax) Weights Cost Debt CELL REF 45% FORMULA Preferred stock CELL REF 15% FORMULA Common equity (retained earnings) CELL REF 40% FORMULA Weighted average cost of capital 100% FORMULA b. If the firm has $12 million in retained earnings, at what size of investment will the firm run out of retained earnings? Retained earnings $12,000,000 Capital structure size FORMULA c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 40 percent of the capital structure, but will all be in the form of new common stock.) Cost Weighted (after tax) Weights Cost Debt CELL REF 45% FORMULA Preferred stock CELL REF 15% FORMULA Common equity (new common) CELL REF 40% FORMULA Weighted average cost of capital 100% FORMULA d. The 5.6 percent cost of debt referred to above applies only to the first $18 million of debt. After that the cost will be 7.2 percent. At what size of investment will there be a change in the cost of debt? Capital structure size FORMULA e. What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts c and d.) Cost Weighted (after tax) Weights Cost Debt VALUE 45% FORMULA Preferred stock 9.00% 15% FORMULA Common equity (new common) CELL REF 40% FORMULA Weighted average cost of capital 100% FORMULA

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