Can someone explain why we consider Retained earnings when calculating Break Points? I understand the calculation of break points for debt and equity. thanks.
hi what exactly is your question? I guess for calculating cost of equity, you would consider the market value of equity, not the book value, right? retained earnings would be a part of book value of equity. do you have an example in the curriculum? cheers
Here is a question from Schweser’s Qbank: Axxo Corp. has the following capital structure: 40 percent debt and 60 percent equity. The cost of retained earnings is 13 percent and the cost of new common stock is 15 percent. Axxo expects its retained earnings to be $240 million. Its before tax cost of debt is 10 percent and its corporate tax rate is 35 percent. At what point, in terms of its total capital requirements, will Axxo experience a break-point in its marginal cost of capital? A) $42 million. B) $78 million. C) $240 million. D) $400 million. Click for Answer and Explanation Break- point = RE/equity weight = 240,000,000/0.6 = $400,000,000