A companys schedule of the costs of debt and equity shows that additional $ million of debt can be issued at an after tax cost of 3% and additional equity of $9 million at a cost of 6%. The company plans to maintain a capital structure of 30% debt and 70% equity. At what level of new capital financing will the marginal cost of capital change with the issuance of new debt? A. $3 million B. $10 million C. $9 million D. $12.86 Can someone explain this? Thanks

you missing a number next to dollar sign. if that number is 1, so the level at which MCC will change upward is 1000000/.3= 3333333. answer A

How much debt can be issued for 3%? I think you have missed the digit. Anyway, the calulation goes like this: Amount of debt before % cost change/proportion of debt in capital structure= x $9m/0.7 = 12.86m which ever is lower out of x and 12.86 is your answer. This simulates building the capital structure in the correct proportion and finding the â€˜break pointâ€™.

3 Million Sorry

And the answer is B

answer is 10 = B

If $3M can be raised changing the cost of debt, and keeping the same capital structure, the $3M represent 30%, how much would 70% be? 7M. Total, 3M+7M=10M

Ok so they can offer $9 million/.7 more equity before changing marginal cost of equity?

No, the amount of debt that can be raised at an after tax cost of 3% is 3M, the amount of equity that can be raised at an after tax cost of 6% is 9M. Beyond/or at these thresholds, the cost changes. 9/.7 is how much capital would in total be raised, if from equity was 9M (9/.7=12.86, of which 9M equity and the rest 12.86-9=3.86 would have been debt, and the capital structure of 30% debt and 70% equity would have remained the same).