Matsumoto Limited (ML), a large conglomerate firm, has a capital structure that currently consists of 20 percent long-term debt, 10 percent preferred stock, and 70 percent common equity. ML has determined that it will raise funds in the future using 40 percent long-term debt, 10 percent preferred stock, and 50 percent common equity.
ML can raise up to $50 million in the long-term debt market at a pretax cost of 18 percent. Beyond $50 million, the pretax cost of long-term debt is expected to increase to 20 percent. Preferred stock can be raised at a cost of 19 percent. The limited demand for this security permits ML to sell only $20 million of preferred stock. ML's marginal tax rate is 40 percent.
ML's stock currently sells for $40 per share and has a beta of 1.5. ML pays no dividends and is not expected to pay any dividends for the foreseeable future. Invest- ment advisory services expect the stock price to increase from its current level of $40 per share to a level of $99.50 per share at the end of 5 years. New shares can be sold to net the company $38.35. ML expects earnings after taxes and available for com- mon stockholders to be $60 million.
Compute the marginal cost of capital schedule for ML, and determine the break points in the schedule.