Question

Q2o.2 The following information about the cost and availability of raising various amounts of new Debt and Equity capital for XYZ company Amount of new debt Cost of debt Amount of new egity Cost of Equity (in Millions) (After Tax) (in Millions) SPKR 40 14% S PKR 50 > PKR 40 16% > PKR 50 2255 The company's target capital structure is 60% equity and 40% debt. What are the break points? Constret the MCC schedule.

Please give me solution this question in simple method

Answer 1

Calculation of break points :

Breakpoints are defined as the total financing that can be done before the firm is forced to sell new debt or equity capital. Once the firm reaches this break point, if they choose to raise additional capital their WACC increases.

Break point = Debt / Debt weight

If the debt is up to PKR 40 million

Break point = 40/0.4

= PKR 100 million ( For Debt PKR 40 million, For Equity PKR 60 Million)

If the Debt is > PKR 40 million , Break point is more than PKR 100 million

Break point = Equity / Equity weight

If the Equity is up to PKR 50 million

Break point = 50/0.6

= PKR 83.3333 million (For Debt PKR 33.33 million,For Equity PKR 50 Million )

If the Equity is > PKR 50 million , Break point is more than PKR 100 million

Construction of MCC (Marginal Cost of Capital) schedule :

We can see the schedule figures below table :

Formula for WACC = (Equity Cost * Equity weight ) + (Debt Cost * Debt Weight)   

Capital	Equity (60%)	Debt (40%)	WACC
70	42	28	17.6%
80	48	32	17.6%
90	54	36	18.8%
100	60	40	18.8%
110	66	44	19.6%
120	72	48	19.6%

We can see the schedule below :

WACC 19.6%. 1818/ 14.67 70 80 90 100 110 120 Capital