The McGee Corporation finds it is necessary to determine its marginal cost of ca
ID: 2750660 • Letter: T
Question
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current capital structure calls for 40 percent debt, 5 percent preferred stock, and 55 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, 5.2 percent; preferred stock, 8.0 percent; retained earnings, 10.0 percent; and new common stock, 10.2 percent.
What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained earnings, Ke.) (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.)
If the firm has $38.5 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
What will the marginal cost of capital be immediately after that point? (Equity will remain at 55 percent of the capital structure, but will all be in the form of new common stock, Kn.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
The 5.2 percent cost of debt referred to above applies only to the first $22 million of debt. After that, the cost of debt will be 7.2 percent. At what size capital structure will there be a change in the cost of debt?(Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts cand d.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)
The McGee Corporation finds it is necessary to determine its marginal cost of capital. McGee’s current capital structure calls for 40 percent debt, 5 percent preferred stock, and 55 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, 5.2 percent; preferred stock, 8.0 percent; retained earnings, 10.0 percent; and new common stock, 10.2 percent.
Explanation / Answer
Answer for question no.1:
Answer for question no.b:
Formula to be used= Retained earnings/% of retained earnings in the capital structure.
Given retained earnings =$38.50.
Weight of retained earnings in the capital structure =55%
=$38.50 /55%
=$70 million.
Answer for question no.c:
Marginal cost of capital is as follows:
Marginal cost of capital =8.09%
Answer for question no.d:
Formula to determine the capital structure at which there will be change in the cost of debt is as follows
=Amount of cost of debt/% of debt in the capital structure.
=22million/40%
=$55million.
Answer for question no.e:
Marginal cost of capital immediately after the above point is as follows:
Marginal cost of capital =8.89%
Particulars Weight (a) Cost of capital(b) Weighted cost C=a*b Debt 40% 5.20% 2.0800% Preferred stock 5% 8% 0.4000% Common equity 55% 10% 5.5000% Total 7.9800%Related Questions
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