Delta Corporation has the following capital structure: Cost Weighted (aftertax)

Question

Delta Corporation has the following capital structure:

Cost Weighted

(aftertax) Weights Cost

Debt (kd) 10.6% 15% 1.59%

Preferred stock(kp) 9.8 2.5 2.45

Common Equity(ke) 8.2 60 4.92

Weighted average cost of capital (Ke) 8.96%

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a. If the firm has $51 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (enter your answer in millions of doll;ars(e.g. $10 milliomn should be entered as "10").

Capital structure size (X) $_________________million

b. The 10.6 percent copst of debt referred to earlier applies only to the first $18 million of debt. After that the cost of debt will go up. At what size capital structure will there be a cchange in the ost of debt? (enter your answer in millions of dollars.

Capital struture size (Z) $_________________million

Explanation / Answer

Answer:

Assuming that its equity only consists of retained earning:

a) Capital structure size = X = Retained earnings/Weight of equity = $51million/60% = $83.33 millions (Ans)

b) Capital structure size (Z) = Max amount of lower cost debt/Weight of debt in capital structure

                                        = $18 million/15% = $120 millions (Ans)

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