Integrative-WACC, WMCC, and IOS Cartwell Products has compiled the data shown in the following table for the current costs of its three basic sources of capital-long-term debt, preferred stock, and common stock equity-for various ranges of new financing.
|
Source of capital
|
Range of new financing
|
After-tax cost
|
|
Long-term debt
|
$0 to $320,000 $320,000 and above
|
6% 8
|
|
Preferred stock
|
$0 and above
|
17%
|
|
Common stock equity
|
$0 to $200,000
|
20%
|
|
$200,000 and above
|
24
|
The company's capital structure weights used in calculating its weighted average cost of capital are shown in the following table.
|
Source of capital
|
Weight
|
|
Long-term debt
|
40%
|
|
Preferred stock
|
20
|
|
Common stock equity
|
40
|
|
Total
|
100%
|
a. Determine the break points and ranges oftotalnew financing associated with each source of capital.
b. Using the data developed in part a, determine the break points (levels oftotalnew financing) at which the firm's weighted average cost of capital will change.
c. Calculate the weighted average cost of capital for each range of total new financing found in part b.
d. Using the results of part c, along with the following information on the available investment opportunities, draw the firm's weighted marginal cost of capital (WMCC) schedule and investment opportunities schedule (IOS) on the same set of axes (total new financing or investment on thexaxis and weighted average cost of capital and IRR on theyaxis).
|
Investment
|
Internal rate of
|
Initial
|
|
opportunity
|
return (IRR)
|
investment
|
|
A
|
19%
|
$200,000
|
|
B
|
15
|
300,000
|
|
C
|
22
|
100,000
|
|
D
|
14
|
600,000
|
|
E
|
23
|
200,000
|
|
F
|
13
|
100,000
|
|
G
|
21
|
300,000
|
|
H
|
17
|
100,000
|
|
I
|
16
|
400,000
|
e. Which, if any, of the available investments do you recommend that the firm accept? Explain your answer.