The Nolan Corporation finds it is necessary to determine its marginal cost of ca

Question

The Nolan Corporation finds it is necessary to determine its marginal cost of capital. Nolan’s current capital structure calls for 35 percent debt, 30 percent preferred stock, and 35 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, 8.3 percent; preferred stock, 11 percent; retained earnings, 9 percent; and new common stock, 12.2 percent.

a. What is the initial weighted average cost of capital? (Include debt, preferred stock, and common equity in the form of retained eanings, ) (Do not round intermediate calculations. Input your answers as a percent rounded to 2 decimal places.) Weighted Cost Debt Preferred stock Common equity Weighted average cost of capital 0.00 % b. If the firm has $42 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").) Capital structure size (x) million c. What will the marginal cost of capital be immediately after that point? (Equity will remain at 35 percent of the capital structure, but will all be in the form of new common stock, K) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Marginal cost of capital d. The 8.3 percent cost of debt referred to earlier applies only to the first $35 million of debt. After that, the cost of debt will be 9.3 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").) Capital sructure size million e. What will the marginal cost of capital be immediately after that point? (Consider the facts in both parts c and d.) (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.)

Explanation / Answer

Weighted cost = Weight x Cost and WACC = sum of weighted cost (WC)

b) Capital Size = Retained Earnings / % equity = 42 / 35% = $120 million

c) Beyond 120m, cost of equity = 12.2% (instead of 9%), which changes WACC = 10.48%

d) Capital size = Debt / % debt = 35 / 35% = $100 million

e) With cost of equity = 12.2% and debt cost = 9.3%, WACC = 10.83%

Weight Cost W. C. Debt 35% 8.30% 2.91% Pref. Stock 30% 11% 3.30% Equity 35% 9% 3.15% WACC 9.36%

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