1. Thick Brain Inc. has determined that its optimal capital structure is to finance all its investments with 55% debt and 45% equity.

The after tax cost of debt is 8%.

The required rate of return by stockholders who own Thick stock is 10%. So (D/P + g = 10%) = $1 and P = $20, and g= 5%

On a per share basis, it costs Thick $4 a share to float or sell new common stock.

Based on its dividend policy and projected earnings, Thick projects that it will have $9,000,000 in retained earnings to finance proposed investments.

Required:

1. Calculate the marginal cost of capital to be used as the discount rate for a capital budget less than $20,000,000.
2. Calculate the marginal cost of capital for a capital budget greater than $20,000,000.
3. Calculate the average cost of capital for $30,000,000.

Reminder:

Kd = I (1-tx rate) given in this problem to be 8%

Kre = D/P + g = 10%

Kcs = D/ P-fc + g = 11.25%

2. Refer to number 1 above. a. and b. Calculate the following problem based on the optimal capital structure being .40 debt and .60 equity.

1. Calculate the marginal cost of capital at $10,000,000 and

b. Calculate the marginal cost of capital at $16,000,000.

c. Calculate average cost of capital for a capital budget of $20,000,000.