Problem: Fanatics Company uses only debt and common equity in its capital structure. It can borrow funds at an interest rate of 12%. Its current dividend was $1.00; its expected constant growth rate is 5%, its stock sells for $8; and new common stock would sell, net of flotation costs, at $7 per share. Fanatics tax rate is 40% and it expects to have $10 million in retained earnings this year. Its target capital structure is 60% debt and 40% common equity.

1. What is Fanatics weighted average cost of capital before the break point?
2. What is Fanatics weighted average cost of capital after the break point?
3. What is the break point amount?

Answer: (1) 11.57%

(2) 12.32%

(3) $25 million