Question

Cartwell Products has compiled the data shown in the following table for the current costs of its three basic sources of capital—long-term debt, preferred stock, and common stock equity—for various ranges of new financing.

Source of capital	Range of new financing	After tax cost
Long term debt	$0 to $ 320 000 $320 000 and above	6% 8%
Preferred stock	$0 and above	17%
Common stock equity	$0 to $ 200 000 $ 200 000 and above	20% 24%

The company’s capital structure weights used in calculating its weighted average cost of capital are shown in the following table.

Sources of capital	Weight
Long term debt	40%
Preferred stock	20%
Common stock equity	40%
Total	100%

a. Determine the break points and ranges of total new financing associated with each source of capital.

b. Using the data developed in part a, determine the break points (levels of total new financing) at which the firm’s weighted average cost of capital will change.

c. Calculate the weighted average cost of capital for each range of total new financing found in part b above (Hint: There are three ranges.)

d. Using the results of part c, along with the following information on the available

Answer 1

Solution a)

For debt, the fraction or weightage in the capital structure = 40%
Hence, break point = 320000/40% = $800,000

For common equity, the fraction in the capital structure = 40%

Hence, break point = 200000/40% = $500000

The ranges are given as follows:

Solution b) The break-points are given as follows:

Break point1: 0 to 500000*

Break point2: 500000 to 800000*

*At these points, WACC will change

These are the points at which the weighted average cost of capital will change.

Solution c) For Range 1: 0 to 500000

For Range 2: 500000 to 800000

For Range 3: 800000 and above

Please provide the question d.

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