A. Panyam Company’s capital structure in terms of market value is:
Debt Rs.30 million
Equity Rs.60 million
The company plans to maintain this market-value capital structure. It has a plan to invest
Rs.15 million next year. This will be financed as follows:
Retained earnings Rs.5 million
Additional equity Rs.5 million
Debt Rs.5 million
The company’s equity stock presently sells for Rs.30 per share. The next dividend expected is
Rs.3.00. The expected rate of dividend growth is 5 per cent. Additional equity can be issued
at Rs.25 per share (net). The interest rate applicable to additional debt would be as follows:
First Rs.2.5 million 14 per cent
Next Rs.2.5 million 15 per cent
The tax rate for the firm is 60 per cent.
Required: (a) At what amounts of new capital will there be breaks in the marginal cost of
capital schedule?
(b) What will be the marginal cost of capital in the interval between each of the
breaks?