Chapter 11 The Cost of Capital 291

(b) Breaking point

=
ji
AFW (1)
[]
common equity
$100,000BP $200,0000.50
==
Type of CapitalTargetCapitalStructure %Cost of CapitalSourceWeightedCost
(2) WACC equal to or below$200,000 BP:Long-term debt 0.30 5.1% 1.53%Preferred
stock 0.20 8.4% 1.68%Common stock equity 0.50 13.8% 6.90%WACC
=
10.11%(3)WACC above $200,000 BP:Long-term debt 0.30 5.1% 1.53%Preferred stock
0.20 8.4% 1.68%Common stock equity 0.50 15.0% 7.50%WACC
=
10.71%P11-17. LG 4, 5, 6: Integrative–WACC, WMCC, and IOSChallenge(a)
Breaking Points and Ranges:Sourceof CapitalCost%Range of New
FinancingBreakingPointRange of TotalNew Financing
Long-term debt 6 $0
−
$320,000 $320,000
÷
0.40
=
$800,000 $0
−
$800,0008$320,001and aboveGreater than$800,000Preferred stock 17 $0 and above
Greater than $0Common stock 20 $0
−
$200,000 $200,000
÷
0.40
=
$500,000 $0
−
$500,000equity 24 $200,001and aboveGreater than$500,000(b) WACC will change at
$500,000 and $800,000.
292 Part 4 Long-Term Financial Decisions
(c)
WACCSource of CapitalTargetProportionCost %Weighted Cost(2)
×
(3)Range of TotalNew Financing(1) (2) (3) (4)
$0
−
$500,000 Debt 0.40 6 2.40%Preferred 0.20 17 3.40%Common 0.40 20 8.00%WACC
=
13.80%$500,000
−
$800,000 Debt 0.40 6% 2.40%Preferred 0.20 17% 3.40%Common 0.40 24%
9.60%WACC
=
15.40%Greater than Debt 0.40 8% 3.20%$800,000 Preferred 0.20 17% 3.40%Common
0.40 24 9.60%WACC
=
16.20%(d)
IOS Data for GraphInvestment IRRInitialInvestmentCumulativeInvestment
E 23% $200,000 $200,000C 22 100,000 300,000G 21 300,000 600,000A 19 200,000
800,000H 17 100,000 900,000I 16 400,000 1,300,000B 15 300,000 1,600,000D 14
600,000 2,200,000F 13 100,000 2,300,000
121314151617181920212223240 300 600 900 1200 1500 1800 2100 2400 2700
IOS and WMCCWeighted AverageCost of Capital/Return (%)Total New Financing or
Investment (000)

Chapter 11 The Cost of Capital 293

(e) The firm should accept investments E, C, G, A, and H, since for each of these, the
internalrate of return (IRR) on the marginal investment exceeds the weighted marginal
cost of capital(WMCC). The next project (i.e., I) cannot be accepted since its return of
16% is below theweighted marginal cost of the available funds of 16.2%.P11-18. LG 4, 5,
6: Integrative–WACC, WMCC, and IOCChallenge(a) WACC: 0 to $600,000
=
(0.5)(6.3%)
+
(0.1)(12.5%)
+
(0.4)(15.3%)
=
3.15%
+
1.25%
+
6.12%
=
10.52%WACC: $600,001
−
$1,000,000
=
(0.5)(6.3%)
+
(0.1)(12.5%)
+
(0.4)(16.4%)
=
3.15%
+
1.25%
+
6.56%
=
10.96%WACC: $1,000,001 and above
=
(0.5)(7.8%)
+
(0.1)(12.5%)
+
(0.4)(16.4%)
=
3.9%
+
1.25%
+
6.56%
=
11.71%See part (c) for the WMCC schedule.(b) All four projects are recommended for
acceptance since the IRR is greater than the WMCCacross the full range of investment
opportunities.(c)
1011121314150 200 400 600 800 1000 1200 1400 1600 1800 2000HGKMAWMCCIOS
IOS and WMCCWeighted AverageCost of Capital/Return (%)Total New
Financing/Investment ($000)(d)
In this problem, projects H, G, and K would be accepted since the IRR for these
projectsexceeds the WMCC. The remaining project, M, would be rejected because the
WMCC isgreater than the IRR.

294 Part 4 Long-Term Financial Decisions

P11-19. Ethics ProblemIntermediateAnalysts familiar with WorldCom complained that
much of the $105 billion of its assets consistedof intangibles and goodwill amassed in the
process of nearly 70 acquisitions. As a result, precisevaluation of its assets was almost
impossible. Many feared that assets were equally inflated asWorldCom’s income
statements. Indeed, after declaring Chapter 11, the company wrote off $35 billion in plant
and equipment in addition to $45 billion in goodwill wiping out any equity leftfrom the
books.

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Chapter 11 The Cost of Capital 291
(b) Breaking point
=
ji
AFW (1)
[]
common equity
$100,000BP $200,0000.50
==
Type of CapitalTargetCapitalStructure %Cost of CapitalSourceWeightedCost
(2) WACC equal to or below$200,000 BP:Long-term debt 0.30 5.1% 1.53%Preferred
stock 0.20 8.4% 1.68%Common stock equity 0.50 13.8% 6.90%WACC
=
10.11%(3)WACC above $200,000 BP:Long-term debt 0.30 5.1% 1.53%Preferred stock
0.20 8.4% 1.68%Common stock equity 0.50 15.0% 7.50%WACC
=
10.71%P11-17. LG 4, 5, 6: Integrative–WACC, WMCC, and IOSChallenge(a)
Breaking Points and Ranges:Sourceof CapitalCost%Range of New
FinancingBreakingPointRange of TotalNew Financing
Long-term debt 6 $0
−
$320,000 $320,000
÷
0.40
=
$800,000 $0
−
$800,0008$320,001and aboveGreater than$800,000Preferred stock 17 $0 and above
Greater than $0Common stock 20 $0
−
$200,000 $200,000
÷
0.40
=
$500,000 $0
−
$500,000equity 24 $200,001and aboveGreater than$500,000(b) WACC will change at
$500,000 and $800,000.

292 Part 4 Long-Term Financial Decisions

(c)
WACCSource of CapitalTargetProportionCost %Weighted Cost(2)
×
(3)Range of TotalNew Financing(1) (2) (3) (4)
$0
−
$500,000 Debt 0.40 6 2.40%Preferred 0.20 17 3.40%Common 0.40 20 8.00%WACC
=
13.80%$500,000
−
$800,000 Debt 0.40 6% 2.40%Preferred 0.20 17% 3.40%Common 0.40 24%
9.60%WACC
=
15.40%Greater than Debt 0.40 8% 3.20%$800,000 Preferred 0.20 17% 3.40%Common
0.40 24 9.60%WACC
=
16.20%(d)
IOS Data for GraphInvestment IRRInitialInvestmentCumulativeInvestment
E 23% $200,000 $200,000C 22 100,000 300,000G 21 300,000 600,000A 19 200,000
800,000H 17 100,000 900,000I 16 400,000 1,300,000B 15 300,000 1,600,000D 14
600,000 2,200,000F 13 100,000 2,300,000
121314151617181920212223240 300 600 900 1200 1500 1800 2100 2400 2700
IOS and WMCCWeighted AverageCost of Capital/Return (%)Total New Financing or
Investment (000)

Chapter 11 The Cost of Capital 293

(e) The firm should accept investments E, C, G, A, and H, since for each of these, the
internalrate of return (IRR) on the marginal investment exceeds the weighted marginal
cost of capital(WMCC). The next project (i.e., I) cannot be accepted since its return of
16% is below theweighted marginal cost of the available funds of 16.2%.P11-18. LG 4, 5,
6: Integrative–WACC, WMCC, and IOCChallenge(a) WACC: 0 to $600,000
=
(0.5)(6.3%)
+
(0.1)(12.5%)
+
(0.4)(15.3%)
=
3.15%
+
1.25%
+
6.12%
=
10.52%WACC: $600,001
−
$1,000,000
=
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+
(0.1)(12.5%)
+
(0.4)(16.4%)
=
3.15%
+
1.25%
+
6.56%
=
10.96%WACC: $1,000,001 and above
=
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+
(0.1)(12.5%)
+
(0.4)(16.4%)
=
3.9%
+
1.25%
+
6.56%
=
11.71%See part (c) for the WMCC schedule.(b) All four projects are recommended for
acceptance since the IRR is greater than the WMCCacross the full range of investment
opportunities.(c)
1011121314150 200 400 600 800 1000 1200 1400 1600 1800 2000HGKMAWMCCIOS
IOS and WMCCWeighted AverageCost of Capital/Return (%)Total New
Financing/Investment ($000)(d)
In this problem, projects H, G, and K would be accepted since the IRR for these
projectsexceeds the WMCC. The remaining project, M, would be rejected because the
WMCC isgreater than the IRR.

294 Part 4 Long-Term Financial Decisions

P11-19. Ethics ProblemIntermediateAnalysts familiar with WorldCom complained that
much of the $105 billion of its assets consistedof intangibles and goodwill amassed in the
process of nearly 70 acquisitions. As a result, precisevaluation of its assets was almost
impossible. Many feared that assets were equally inflated asWorldCom’s income
statements. Indeed, after declaring Chapter 11, the company wrote off $35 billion in plant
and equipment in addition to $45 billion in goodwill wiping out any equity leftfrom the
books.

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