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 - What is the Weighted Average Cost of Capital (WACC) after the first breakpoint?

Explanation / Answer

Step 1: Calculate Cost of Equity at First Break Even Point

The cost of equity at first break even point is calculated as follows;

Cost of Equity = Expected Dividend/(Current Share Price*(1-Flotation Cost)) + Growth Rate

Using the values provided in the question in the above formula, we get,

Cost of Equity = 2/(25*(1-10%)) + 3% = 11.89%

_____

Step 2: Calculate WACC at First Break Even Point

The WACC at first break even point is calculated as below:

WACC = Weight of Debt*Cost of Debt*(1-Tax Rate) + Weight of Equity*Cost of Equity = 30%*8%*(1-35%) + 70%*11.89% = 9.88% (answer)

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