NCC Corporation is considering building a new facility in Texas. To raise money
ID: 2789919 • Letter: N
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 SECOND breakpoint? I repeat, after the SECOND breakpoint.
Explanation / Answer
The first breakpoint is at total capital = Retained Earnings / Weight of equity = 66 / 70% = $94.3 million
The second breakpoint is at total capital = Debt / Weight of debt = 30 / 30% = $100 million
Cost of debt after $30 million in debt, kd = 12.5%
Cost of equity after $66 million in equity, ke = D1 / P x (1 - f) + g = 2 / 25 x (1 - 10%) + 3% = 11.9%
WACC = we x ke + wd x kd x (1 - tax) = 70% x 11.9% + 30% x 12.5% x (1 - 35%) = 10.76% is the WACC after the second breakpoint.
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