Question: What does a company's cost of capital represent and how is it calculated? How do market prices and the company's perceived market risk impact its cost of capital, & how does the company's debt to equity mix impact this cost of capital? Apply the information provided; make a spreadsheet to compute weighted average cost & marginal weighted average cost of capital for Strident Marks?
You have developed the following table concerning the cost of capital sources for Strident Marks:
|
Source of capital
|
After tax cost
|
|
Long term debt
|
6%
|
|
Preferred stock
|
18%
|
|
Common stock equity
|
20%
|
Strident Marks capital structure weights used to calculate its WACC are:
|
Source of Capital
|
After Tax Cost
|
Amount Available
|
After tax cost, After Break Point
|
|
Long term debt
|
6%
|
200,000
|
12%
|
|
Preferred stock
|
18%
|
100,000
|
25%
|
|
Common stock equity
|
20%
|
200,000
|
40%
|
The future investment opportunities & the corresponding Internal Rate of Return [IRR] follow. As a result of operating its business operations profitably, Strident Marks has 1,000,000 dollar to invest. Considering Strident Marks' weighted average cost of capital & MCC, rank the investment opportunities & indicate which ones would be accepted, which [if any] would be rejected & why.
|
Investment Opportunity
|
IRR
|
Initial Investment
|
|
A
|
20%
|
$300,000
|
|
B
|
16%
|
$350,000
|
|
C
|
23%
|
$300,000
|
|
D
|
15%
|
$450,000
|
|
E
|
24%
|
$250,000
|
|
F
|
14%
|
$400,000
|
|
G
|
22%
|
$200,000
|
|
H
|
18%
|
$150,000
|
|
I
|
17%
|
$100,000
|