10.8: MCC Example

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Calculate the Marginal Cost of Capital Based on the following information.

Price per share of Common Stock	$45
Price per share of Preferred Stock	$60
Price per Bond ($1000 par value)	$865
Number of shares of Common Stock Outstanding	2,300,000
Number of shares of Preferred Stock Outstanding	500,000
Number of Bonds Outstanding	60,000
Coupon Rate on Bonds	5%
Time Remaining Until Maturity for Bonds	15 years
Marginal Tax Rate	25%
Par Value of Preferred Stock	$50
Dividend Rate on Preferred Stock	9%
Common Stock Dividend (D1)	$3.00
Dividend Growth Rate (Common)	6%
Risk-Free Rate	5%
Beta	1.2
Expected Return on the Market	12%
Risk Premium on Stocks over Bonds	4.50%

Step 1: Find the Weights

MV_debt =60,000*865 = $51,900,000
MV_preferred = 500,000*$60 = $30,000,000
MV_common = 2,300,000*45 = $103,500,000
MV _TOTAL = $185,400,000

W_debt = 51,900,000/185,400,000 = 0.28
W_pref = 30,000,000/185,400,000 = 0.16
W_com = 103,500,000/185,400,000 = 0.56

Step 2: Find the after-tax cost of debt

Find YTM

Set Financial Calculator to 2 Periods Per Year
30 N
-865 PV
25 PMT
1000 FV
Solve for I/Y = 6.41%

Convert to After-tax Cost k_i = YTM*(1-T)

k_i = 6.41%*(1 – 0.25)
k_i = 4.81%

Step 3: Find the cost of preferred stock

k_p = D/P
k_p = ($50*.09)/$60
k_p = $4.50/$60
k_p = 7.50%

Step 4: Find the cost of common stock

Method One — Dividend Valuation Approach

k_s = (D₁/P) + g
k_s = ($3.00/$45.00) + 0.06
k_s = 0.0667 + 0.06
k_s = 12.67%

Method Two – Security Market Line (SML)

\[
k_s=k_{R F}+\beta\left(\overline{k_m}-k_{R F}\right)
\notag \]

k_s = 5% + 1.20(12% – 5%)
k_s = 5% + 1.20(7%)
k_s = 5% + 8.4%
k_s = 13.4%

Method Three — Bond Yield + Risk Premium

k_s = YTM + RP
k_s = 6.41% + 4.5%
k_s = 10.91%

Take an average of the three methods to get cost of common stock financing

k_s = (12.67% + 13.40% + 10.91%)/3
k_s = 36.98/3
k_s = 12.33%

Step 5: Calculate the MCC

MCC = (W_debt )(k_i) + (W_pref)(k_p) + (W_com)(k_s)
MCC = (0.28*4.81) + (0.16*7.50) + (0.56*12.33)
MCC = 1.35 + 1.20 + 6.90
MCC = 9.45%

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