Target(optimal) capital structure :
Long term debt 50%
Preferred stock 10%
Commonequity 40%
After tax component costs:
Long term debt 6%
Preferred stock 10%
Retained earnings 14%
New common stock expected total earnings(net income) for the year in millions $120
Target dividend payout ratio 45%
If the company raises $150 m in new capital,the company’s marginal cost of capital is closest to
What in the world is this question saying?
I don’t know, but it’s weird that the answers are:
(The answer’s straightforward: use the WACC formula, noting that they’ve already included (1 – t) in the cost of debt. I have no idea what they mean “New common stock expected total earnings(net income) for the year in millions” (Does that include a typo, perhaps?), and the target dividend payout ratio is a red herring.)
Is before tax cost of preferred stock same as after tax cost of preferred stock? Is there anything called after tax cost of preferred equity also? Can you give an example of how a break point question could be like in the previous example?
Yes: preferred dividends are not tax-deductible.
They just call it the cost of preferred equity, as taxes don’t affect it.
I’m not sure I understand your question.
Can you frame a question on “calculation of break point” in the example given by mokpokpo here?
Nope. We need more data.
Breakpoints occur when there is an abrupt change in MCC: for example, we can borrow up to $50 million at 6%, but above that we’ll have to pay 7%; there will be a breakpoint at the capital budget level that corresponds to $50 million in debt. Given that debt is supposed to be 50% of the capital structure, that would give us a breakpoint at a capital budget of $100 million (= $50 million ÷ 50%).
Cool!