Problem 1: Break point associated with common equity. O'Grady plans to use 25% long term debt in its capital structure. Every $1 in debt the firm uses, it will use $3 from other financing sources.
Total financing is then $4, because $1 comes from long term debt, its share in the total is the desired 25%.
After firm raises $700,000 in long term debt, financing source rises, the firm can raise total capital of 2.8 million in other sources to maintain the 25% for debt. 2.8 million is the break point for debt.
Firm wants to maintain 25% long term debt, wants to raise more that 2.8 million in total financing, it will require more than $700,000 in long term debt, and it will trigger the higher cost of the additional debt it issues beyond 700,000.
Problem 2. Using the break points developed in part (1), determine each of the ranges of total new financing over which the firm's weighted average cost of capital (WACC) remains constant.
Problem 3. Calculate the weighted average cost of capital for each range of total new financing.