Marginal cost of capital schedule

Marginal Cost of Capital (MCC) Schedule is a graph that relates the firm’s weighted average cost of each dollar of capital to the total amount of new capital raised.

The WACC is the minimum rate of return allowable, and still meeting financial obligationts such as debt, interest payments, dividends etc... Therefore, the WACC averages the required returns from all long-term financing sources (Debt and Equity).

the WACC is based on cash flows, which are after-tax. By the same notion then, the WACC should be calculated on an after-tax basis.

WACC Components

DEBT

Advantages:
- usually cheaper than equity
- no loss of control (voting rights)
- upper limit is placed on share of profits
- floatation costs are typically lower than equity
- interest expense is tax deductible

Disadvantages:
- legally obliged to make payments no matter how tight the funds on hand are
- in the case of bonds, full face value comes due at one time
- taking on more debt = taking on more financial risk (more systematic risk) requiring higher cash flows

The firm's debt component is stated as k_d and since there is a tax benefit from interest payments then the after tax WACC component is k_d(1-T); where T is the tax rate.
Equity

Advantages:

- no legal obligation to pay (depends on class of shares)
- no maturity
- lower financial risk
- it could be cheaper than debt, with good prospects of profitability

Disavdantages:

- new equity dilutes current ownership share of profits and voting rights (control)
- cost of underwriting equity is much higher than debt
- too much equity = target for a leveraged buy-out by another firm
- no tax shield, dividends are not tax deductible, and may exhibit double-taxation

Cost of new equity should be the adjusted cost for any underwriting fees terme flotation costs (F)

K_e = D₁/P₀(1-F) + g; where F = flotation costs, D₁ is dividends, P₀ is price of the stock, and g is the growth rate.

More to come: (K preferred shares, WACC equation, EVA, MCC, MCC schedule and demonstration, IOS schedule and demonstration, MCC/IOS schedules)