NCC Corporation is considering building a new facility in Texas. To raise money

Question

NCC Corporation is considering building a new facility in Texas. To raise money for the capital projects, the corporation plans the following capital structure: 30% of money will come from issuing bonds, and 70% will come from Retained Earnings or new common stock. The corporation does not currently have preferred stock. NCC Corporation will issue bonds with an interest rate of 8% up to $30 million dollars in bonds. After issuing $30 million in bonds, the interest cost will rise to 12.5%. The next dividend on common stock is expected to be $2.00 per share. The stock price is $25.00 per share, and is expected to grow at 3% per year. The flotation cost for issuing new common stock is estimated at 10%. NCC Corporation has $66 million in retained earnings that can be used. The tax rate for NCC Corporation is 35%.

Q -At what point does the second breakpoint occur?

Explanation / Answer

1ST BREAK POINT: Debt 30 million at 8%, being 30% Required equity = 30*0.7/0.3 = $             70.00 million As retained earnings is only $66 million, the first break point occurs at the total capital of 66/0.7 = $             94.29 million At this point debt = 94.29*30% = $             28.29 million The second break point occurs when debt reaches $30 million. The total capital would be 30/0.30 = $           100.00 million Answer The equity portion from new common stock would be = 70-66 = $                4.00 million

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