Question 14 Roberson Fashion\'s capital structure consists of 30 per cent debt a

Question

Question 14 Roberson Fashion's capital structure consists of 30 per cent debt and 70 per cent ordinary shares. Roberson is considering raising new capital to finance its expansion plans. The company's investment banker has compiled the following information about the cost of debt if the company issues debt: Amount of Debt After-Tax Cost of Debt $1-$150,000 150,001-450,000 450,001-840,000 Above 840,000 6.5% 7.8 9.0 11.0 Roberson expects to generate $350,000 in retained earnings next year. For any new shares issued, Roberson will incur flotation costs of 6 per cent. What are the break points that Roberson faces when computing its marginal cost of capital? [10 marks)

Explanation / Answer

Retained earnings break-even point is = (350000/0.7) = $ 500,000

6.5% debt breakeven point is = 150000/0.3 = $ 500,000

7.8% debt breakeven point is = 450000/0.3 = $ 1,500,000

9.0% debt breakeven point is = 840000/0.3 = $ 2,800,000

So from the above we can conclude as below:-

At $ 500,000 the amount of retained earnings, maximum of 6.5% can be used.

If 1,500,000 the maximum of 7.8% and 9% for $ 2,800,000 is used.

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