Western Transportations capital structure consists of 30 per

Western Transportation\'s capital structure consists of 30 percent debt and 70 percent common equity. According to its investment banker, Western can issue up to $240,000 new debt at a 3.8 percent cost; for any amount of new debt greater than $240,000, the cost is 5.5 percent. Western expects to generate $560,000 in retained earnings this year. Compute the WACC break point(s) associated with raising new funds. 12) 13

Solution

Breakpoints are defined as the total financing that can be done before the firm is forced to sell new debt or equity capital. Once the firm reaches this breakpoint, if they choose to raise additional capital their WACC increases.

Breakpoint for retained earnings = Retained Earnings / Weight of equity
= $560000 / 0.7
= $800,000
Hence $800,000 can be raised in total by the company of which $800000 * 70% = $560,000 of retained earnings and $800,000 * 30% = $240,000 of debt without altering its capital structure.