Question

The chief financial officer of Portland Oil has given you the assignment of determining the firm's marginal cost of capital. The present capital structure which is considered optimal, is: Book Value Market Value Debt $ 80 million $ 60 million Preferred Stock 30 million 30 million Common Equity 100 million 210 million Total $210 million $300 million The anticipated financing opportunities are these: Debt can be issued with a 12 percent before-tax cost. Preferred stock will be $100 par, carry a dividend of 15 percent, and can be sold to net the firm $85 per share. Common equity has a beta of 1.20, the return on the market is 8 percent, and the risk-free rate is 2 percent. The firm's tax rate is 40 percent. The company’s marginal cost of capital (MCC) is:

Answer 1

Answer:

9.645%

Explanation:

According to the scenario, computation of the given data are as follow:-

For calculating the marginal cost of capital we need to first calculate the following things which are given below:

Debt Weight = Market Value of Debt ÷ Total Market Value of Debt × 100

= $60 Million ÷ $300 Million × 100

= 20%

Preferred Stock Weight = Market Value of Preferred Stock ÷ Total Market Value of Preferred Stock × 100

=$30 Million ÷ $300 Million × 100

= 10%

Common Equity Weight = $210 Million ÷ $300 Million × 100 = 70%

Cost of Preferred Stock is

= Dividend ÷ Price

= 15 ÷ $85

= 17.65%

Cost of Equity is

= (Market Return - Risk Free Rate) ×  Beta + Risk Free Rate

= (8 - 2) × 1.20 + 2

= 6 × 1.20 + 2

= 9.2%

Now

Marginal Cost of Capital is

= Cost of Equity × Equity Weight + (1 - Tax Rate) × Debt Weight × Cost of Debt + Cost of Preferred Stock × Preferred Weight

= 9.2 × 0.70 + (1 - 0.40) × 0.20 × 12 + 17.65 × 0.10

= 6.44 + 1.44 + 1.765

= 9.645%