The omni corp has a target capital structure of 60% equity and 40 % debt. The schedule of financing costs for the Omni corp is shown below… Amt of new debt after tax cost of debt amt of new equity cost of equity 0-99 4.2 0-199 6.5 100-199 4.6 200-399 8.0 200-299 5.0 400-599 9.5 calculate the break points ??? now do we have 4 break points or 6 break points??? plz help Thanks
The break point is where the rate changes. The first time there is a break point is when debt hits 100 - then when debt reaches 200 - then when equity hits 200 and then when equity reaches 400. Remember before debt is 100 and before equity is 200 there is no change in rate. There is therefore 4 break points.
You’ll have a break point each time a component cost of capital changes: BP 1 debt is $100. Total financing = 100/.4 = 250. BP 2 equity is $200. Total financing = 200/.6 = 333.34 BP 3 debt is $200. Total financing = 200/.4 = 500. BP 4 equity is $400. Total financing = 400/.6 = 666.67 BP 5 debt is $300. Total financing = 300/.4 = 750. BP 6 equity is $600. Total financing = 600/.6 = 1000
BP 5 debt is $300. Total financing = 300/.4 = 750, but you don’t have an interest rate for more than 300 debt, so at this break point no debt can be raised BP 6 equity is $600. Total financing = 600/.6 = 1000, but this is not possible because there is neither a rate for equity, nor one for debt at 400 so at this break point neither debt not equity can be raised You’ll have 4 BP
thanks …concept is all clear now…
At B5 you would still be able to raise capital, through equity, but you would affect the structure of the capital (you would have more than 60% equity).
You know, I’ve been studying for 4 months and this discussion doesn’t even look remotely familiar to me…darn. I assume this is somewhere in FSA?
Nope, this is in corporate finance, in volume 4