The McGee Corporation finds it is necessary to determine its marginal cost of capital.
McGee's current capital structure calls for 40 percent debt, 5 percent preferred stock, and55 percent common equity.
Initially, common equity will be in the form of retainedearnings (Ke) and then new common stock (Kn).
The costs of the various sources offinancing are as follows:
debt, 7.4 percent;
preferred stock, 10.0 percent;
retained earnings,13.0 percent; and new common stock, 14.4 percent.
a. What is the initial weighted average cost of capital? (Include debt, preferred stock, andcommon equity in the form of retained earnings, Ke.)
b. If the firm has $27.5 million in retained earnings, at what size capital structure will thefirm run out of retained earnings?
c. What will the marginal cost of capital be immediately after that point? (Equity willremain at 55 percent of the capital structure, but will all be in the form of newcommon stock, Kn.)
d. The 7.4 percent cost of debt referred to above applies only to the first $32 million ofdebt. After that the cost of debt will be 8.6 percent. At what size capital structure willthere be a change in the cost of debt?
e. What will the marginal cost of capital be immediately after that point? (Consider thefacts in both partsc andd.)