
Marginal Cost of Capital (MCC) is the weighted average cost of capital for the last dollar raised in new capital. MCC of the company remains constant for some time after which it increases. This depends on the amount of additional capital raised and eventually increases as the cost of raising new capital is higher due to flotation cost. This is mostly evident in case of
Marginal cost of capital is calculated as below:
Proportion of debt in the target capital structure “
Proportion of
Proportion of common equity in the target capital structure “
After tax cost of debt, preferred stock, retained earnings and new equity is “
Breakpoint of retained earnings is the maximum amount of fund that can be raised without issuing new common equity, since the equity portion of the new capital can be met through retained earnings.
There are two independent projects S and L. They have a cost of $150,000 and $140,000 respectively, with an IRR of 12% and 10%. The company’s capital structure consists of 20% debt and 80% common equity. After tax cost of debt, cost of retained earnings and cost of new common equity are 4%,10%,12.5% respectively. The company expects to generate $230,000 in retained earnings.

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