Assume the following information: Type of Capital After-tax Cost Proportion of C

Question

Assume the following information:

Type of Capital                  After-tax Cost                     Proportion of Capital Structure

debt                                          5.0%                                            20.0%

common equity -

retained earnings                     11.0                                            80.0

common equity -

new issue                                   14.0            

The firm expects to reatin $160,000 in earnings this year to invest in capital budgeting projects. If the firm's capital budget is expected to equal $190,000, what required rate of return, or marginal cost of capital, should be used when evaluating capital budgeting projects? What is the WACC if the capital budget is expected to be $220,000?   

Explanation / Answer

Marginal cost of capital = (160,000*11%+30,000*5%)/190,000 = 10.05%

WACC for capital budget of 220,000 = (160,000*11%+60,000*5%)/220000 = 9.36%

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