(Marginal Cost of Capital (MCC), Investment Opportunity Schedule (IOS) and Financing Break points (BPs)

Caldwell Products Limited (CPL) has compiled the following data for its three sources of capital for their various ranges of new financing:

Source of Capital Range of New Financing After-tax costs

Long-term Debt $1 to $320,000 6%

$320,001 and above 8%

Preferred Equity $1 and above 17%

Common Equity $1 to $200,000 20%

$200,001 and above 24%

The optimal capital structure for CPL, as compiled by its financial controller, is as follows:

Source of Capital Weight

• Long-term Debt 40%
• Preferred Equity 20%
• Common Equity 40%

CPL has also identified several investment opportunities for consideration. These are listed below with respected to their expected internal rate of return (IRR):

Investment Opportunity Expected IRR Initial Investment

Project A 19% $200,000

B 15% 300,000

C 22% 100,000

D 14% 600,000

E 23% 200,000

F 13% 100,000

G 21% 300,000

H 17% 100,000

J 16% 400,000

Required:

1. Determine the break-points of new financing associated with each source of capital?
2. Calculate the weighted average cost of capital for each of new financing found in (a) Hint: There are three ranges
3. Using the result in b) and available investment opportunities shown above, draw CPL's Marginal Cost of Capital (MCC) schedule and Investment Opportunity Schedule (IOS)
4. Which, if any, of the available investment do you recommend that CPL select? Why?
5. Calculate the overall cost of capital for CPL. Which projects CPL should select? Is it different from the previous question (d)? If so, explain why.