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14. Fixed Income Investments 11.11 Net Present Value (NPV) and the Internal Rate of Return (IRR)
The marginal cost of capital (MCC) is the cost of the last dollar of capital raised, essentially the cost
of another unit of capital raised. As more capital is raised, the marginal cost of capital rises. Frequently Asked Questions
With the weights and costs given in our previous example, we computed Newco's weighted average What is the difference between a capital good and a
cost of capital as follows: consumer good?
What is a derivative?
WACC = (wd)(kd)(1-t) + (wps)(kps) + (wce)(kce)
WACC = (0.4)(0.07)(1-0.4) + (0.05)(0.021) + (0.55)(0.12) What is an economic moat?
Answer:
Using this new cost of equity, we can determine the WACC as follows:
The WACC has been stepped up from 8.4% to 8.6% given Newco's need to raise new equity.
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Figure 11.1
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At some point, as the company continues to raise capital, the MCC can be higher than the WACC.
Formula 11.9
Example:
For Newco, assume we expect it to earn $50 million next year. As mentioned in our previous
examples, Newco's payout ratio is 30%. What is Newco's breakpoint on the marginal cost curve, if
we assume wce = 55%?
Answer:
Newco's breakpoint = $50 million (1-0.3) = $63.6 million
0.55
Thus, after Newco raises roughly $64 million of total capital, new common equity will need to be
issued and Newco's WACC will increase to 8.6%.
Factors that affect the cost of capital can be categorized as those that are controlled by the company
and those that are not.
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