You develop the following information. Your firm has a target capital structure of 80% common equity, 5% preferred stock and 15% debt. The firm’s tax rate is 25%.
The firm can issue up to $225,000 worth of debt at a before-tax cost of 10%. Then it will cost the firm 11.5% before-tax on debt up to $300,000. After that point, the after-tax cost of debt will be 9.75%.
The firm’s preferred stock carries an annual dividend of $1.75 per share. The issue price of the preferred would be $20 with 2% of the issue price charged as flotation costs. The firm can use up to $125,000 of this preferred stock before the cost will increase to 10%.
The firm expects to have $1,500,000 in earnings and have a dividend payout ratio of 30%. The firm bases its cost of retained earnings on the CAPM approach. For this purpose, you determine the growth rate of the market will be 6% and the market dividend yield is 8%. The risk-free rate is 2.50%. The firm’s beta is 0.80.
The firm can issue new common stock with a $1.00 dividend, price of $25 per share, flotation costs of 4% of issue price and growth rate expected of 8%. This holds for up to $1,400,000 in equity after which it will cost 13% for new common stock.
Determine the marginal cost of capital schedule.