Delta Corporation has the following capital structure: a. If the firm has $16 mi

Question

Delta Corporation has the following capital structure:

a. If the firm has $16 million in retained earnings, at what size capital structure will the firm run out of retained earnings? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
  

b. The 9.1 percent cost of debt referred to earlier applies only to the first $12 million of debt. After that the cost of debt will go up. At what size capital structure will there be a change in the cost of debt? (Enter your answer in millions of dollars (e.g., $10 million should be entered as "10").)
  

Cost
(aftertax) Weights Weighted
Cost Debt (Kd) 9.1 % 40 % 3.64 % Preferred stock (Kp) 10.6 10 1.06 Common equity (Ke) (retained earnings) 9.1 50 4.55 Weighted average cost of capital (Ka) 9.25 %

Explanation / Answer

Answer:

a.X = Retained earnings / Weight of Common Equity

X = $16 million / 0.50 = $32 million

b.Z = Amount of lower cost debt / Weight of Debt

Z = $12 million / .40 = $30 million

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