Let’s suppose that a firm issues two tranches (“series”) of bonds, in addition t

Question

Let’s suppose that a firm issues two tranches (“series”) of bonds, in addition to preferred stock and retained earnings. It has so much retained earnings that it does not have to issue new equity. However, the two different tranches have different flotation costs. How does one calculate the breakpoint for the resulting two WACC’s?

A. Dollar amount of lower cost tranche divided by the We.

B. Dollar amount of lower cost tranche divided by the Wd.

C. Dollar amount of higher cost tranche divided by the Wd.

D. There will not be a breakpoint since there will only be one WACC.

Explanation / Answer

There will not be a breakpoint since there will be one weighted average cost of capital

Weighted average cost of capital = Cost of debt * Weight of debt + Cost of equity * Weight of equity + Cost of preferred stock * Weight of preferred stock

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