No-No Bad Dog (NNBD) Training School wants to maintain its current capital structure of 50%...

Question:

No-No Bad Dog (NNBD) Training School wants to maintain its current capital structure of 50% common equity, 25 % preferred stock, and 25 % debt. Its cost of common equity is 11%, shares of the companies preferred stock are currently paying dividends of 2.50 and are expected to do so in the future, flotation cost is $5/share and the current market price is $30/share. The cost of issuing new common stock is 15.6%. The bank charges an annual rate of interest of 9% for amounts borrowed that is less than or equal to $1 million, and 12% for amounts between $1 million and $2 million. If more than $2 million is borrowed, they charge a 16% annual rate of interest. No-No's tax rate is 25%. The firm expects to net $5,255,000 in income after paying preferred dividends this year. Suppose NNBD's owner leaves a pizza box on the stove in the break room. While they are busy taking a phone call, their bloodhound steals the pizza and starts the building on fire. The firm will need to borrow funds to rebuild their facility.

1) This is likely to affect which of the following? A) Maturity B) Coupon rate C) Discount rate D) Dividends

2) What is NNBD's MCC if $3,000,000 is needed for an upcoming expansion? A) 10.40% B) 11.00% C) 10.60% D) 12.90%

3) NNBD has the opportunity to purchase a competitor's business that will make them the only training school within a 50 mile radius.

The competitor has agreed to sell the business for $5,005,000. What is the MCC for this project? A) 10.40% B) 10.60% C) 12.90% D) 15.60%

Marginal Cost of Capital & Cost of Retained Earnings

Companies need to raise additional funds from external sources according to their target capital structure. Because raising additional amount is costly, companies often calculate the marginal cost of capital which is the weighted average cost of the last buck of new capital raised. In addition, companies often use retained earnings before tapping additional funds from outside sources.

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Given that No-No Bad Dog (NNBD) Training School wants to maintain its current capital structure which is:

CommonPreferredDebt
50%25%25%

The cost of...

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Capital Structure & the Cost of Capital

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Chapter 15 / Lesson 1
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In this lesson, we'll define capital and a firm's capital structure. We'll also discuss the costs associated with each component in the capital structure and learn about the concept of risk and return.


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