Response to the following problem:
The UM Company is evaluating its marginal cost of capital. In consultation with their investment bankers, they have determined that the cost of raising new debt and equity is as follows:
Amount of New Debt Capital Cost
$1 to $1,000,000 5%
$1,000,001 to $2,000,000 7%
$2,000,000 and above 9%
Amount of New Equity Capital Cost
$1 to $3,000,000 10%
$3,000,001 to $6,000,000 12%
$6,000,001 and above 14%
Any new capital that UM raises will be in the proportions of 40% debt and 60% equity.
a. What is the marginal cost of capital if UM raises $1,000,000 new capital? How much of this new capital is debt? How much of this new capital is equity?
b. Calculate the marginal cost of capital schedule, determining the level and cost at each break-point in the schedule.