Calculate the location of the break point

Reference no: EM13290590

The following information pertains to the capital program of a firm:

Target capital structure: 30% debt, 20% preferred stock, 50% equity.

Unadjusted component costs of capital
kd = 10%
kp = 12%
ke = 14%

Flotation Costs, Taxes, and Retained Earnings
Flotation costs are 8% on common and preferred stock and zero on debt
The total effective tax rate (federal and state) is 40%
Retained earnings of $1,250,000 are expected next year.

Investment Opportunities

Project Investment IRR
A $1 million 13.0%
B $2 million 12.5%
C $3 million 11.8%
D $1 million 11.0%

a. Adjust the component costs of capital for taxes and flotation costs, and calculate the WACC before and after the first break.
b. Calculate the location of the break point.
c. Sketch the MCC and the IOS on the same graph. What is the cost of capital for the year? Why?
d. Which projects should the firm undertake? Why?

Reference no: EM13290590

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