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# Mba Acct Essay

469 words - 2 pages

SOLUTION TO INTEGRATIVE CASE PROBLEM:
COST OF CAPITAL

1. Cost of debt:
ki = 9%(1 - 0.4) = 5.4% for the first \$50 million
ki = 10%(1 - 0.4) = 6% for debt exceeding \$50 million.
Cost of equity: (g = 7.2% using the Rule of 72)
ke = \$1.415/\$21 + .072 = .139 or 13.9% for internal equity
ke' = \$1.415/\$19 + .072 = .146 or 14.6% for external equity

2. Size of first interval:
\$50 million first mortgage bonds/0.40 = \$125 million. (Balance of first block of funds is retained earnings with a cost of 13.9%. Debt cost is 5.4%).
ka = 0.4(5.4%) + 0.6(13.9%) = 10.50%

Size of second interval:
...view middle of the document...

16%

MCC curve:
\$0 - \$125 MM 10.50%
\$125 MM - \$166.67 MM 10.74%
\$166.67 MM - \$291.67 MM 11.16%

3. Projects A through F require \$175 million and have returns in excess of the marginal cost of capital.

4. Project G should be rejected because it offers a 10% rate of return and the cost of the funds needed to finance it is 11.16%.

5. If the projects differed substantially in risk, an alternative capital budget might be proposed. Also, it is possible that the firm would be unwilling to raise external equity capital (and thus dilute the ownership interest of current stockholders).

6. a. Cost of debt:
ki = 11%(1 - 0.4) = 6.6% for the first \$50 million
ki = 12.5%(1 - 0.4) = 7.5% for debt exceeding \$50 million.
Cost of equity: (g = 7.2% using the Rule of 72)
ke = \$1.415/\$18 + .072 = .151 or 15.1% for internal equity
ke' = \$1.415/\$16 + .072 = .160 or 16.0% for external equity

b. Cost of first interval:
ka = 0.4(6.6%) + 0.6(15.1%) = 11.70%

Cost of second interval:
ka = 0.4(7.5%) + 0.6(15.1%) = 12.06%

Cost of third interval:
ka = 0.4(7.5%) + 0.6(16.0%) = 12.60%

MCC curve:
\$0 - \$125 MM 11.64%
\$125 MM - \$166.67 MM 12.00% \$166.67 MM - \$291.67 MM 12.60%

c. Choose projects A through E using a total of \$135 million.
d. The interest rate surge has forced Marietta to reject project F, which

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