S & P Corporation (SPC) has an optimal capital structure of 40 percent debt and 60 percent equity. Given the following information, calculate the marginal cost of capital (MCC) schedule and the optimal capital budget. How much is the optimal capital budget and what is the corporate cost of capital?
• 5 years ago, the company issued callable bonds that pay semiannual payment with 6.5% annual coupon rate and sold them at par value ($1,000). However, each bond is currently selling at $960 and has 25 years remaining to maturity.
• SPC’s current stock price is $41.03, its long run growth rate is 4% and its expected earnings per share (EPS1) is $4.00. The company retains 20% of its earnings to fund future growth.
• There are 102.5 million common shares outstanding.
• New common stock may be issued with 5 percent flotation costs.
• SPC has the following Investment Opportunity Schedule(IOS):
Project IRR Cost (millions)
A 15.2% 20
B 12.5% 55
C 9.0% 45
D 7.5% 40
E 6.0% 50