COST OF CAPITAL
Computing the Component Costs
Computing the Break Points
Computing the Weighted Marginal Cost of Capital
Comparing IRR vs. MCC
Computing the Weighted Average Cost of Capital
Computing the NPV of Project B
On January 1, 1997 Bunky's Burgers, Inc. is planning its yearly capital budget and is faced with a list of 5
potential independent proposals:
The firm's capital structure relations shown below are considered optimal and will be maintained:
The firm has a marginal tax rate of 35% and has $4,500,000 from internal sources of equity available for
investment. Four years ago Bunky's paid a common stock dividend of $5.545 a share. Yesterday they paid a
dividend of $7.00. Assume that this dividend growth rate continues for the indefinite future. The common
stock is currently priced to produce a dividend yield
(based on the next dividend)
Bunky's can raise new funds under the following conditions:
(Up to $24,000,000) New 20 year $1000 par value bonds carrying a coupon of 12 per cent (payable
annually) are priced to yield the investor 10% a year. Flotation costs total $70.27 per bond.
(Beyond $24,000,000) A second issue of 20 year 12 per cent coupon bonds can be sold to yield the investor
14% a year. Flotation costs total $67.54.
Any size issue of new preferred stock can be sold to yield the investor 16%.
Underwriters charge a fee of 20% of the selling price.
Issuing up to $7,500,000 of new common stock requires underpricing and flotation
costs equal to 20% of the stock's price. Beyond $7,500,000 requires flotation costs equal to 30% of the