 Use the MCC schedule to find the cost of capital for determining projects’ net present values.

 Investment Opportunity Schedule (IOS)  Graph of the firm’s investment opportunities

ranked in order of the projects’ internal rate of return

2

Marginal Cost of Capital  Cost of additional capital from 1 more

unit of capital raised.  Cost of capital of each additional dollar borrow.

MCC used in Capital Budgeting Firm POWER has 3 Financial executives :  Financial VP  Treasurer

 Director of Capital Budgeting

THE MARGINAL COST OF CAPITAL (MCC) A graph showing how the WACC changes as a firm raises more capital during a planning period, usually a year A Typical MCC Schedule WACC WACC Total Capital Raised

The MCC breaks upward when the cost of a capital component increases. The first break usually occurs when retained earnings runs out and outside equity is raised at higher cost.

MCC Schedule  We can used it to determine the

discount rate used in the capital budgeting process.

Smooth, or Continuous, Marginal Cost of Capital Schedule

MCC Schedule

 Weighted Average Cost of Capital (WACC) (%) WACC

0-

Dollars of New Capital Raised 7

Weighte Average Cost of Capital : 𝑘𝑎= MCC(%)

MCC=11.8%

11.8 MCC=11.3% 11.3 10.8

Break Points

MCC=10.8%

$700,000

$1,000,000

Investment Opportunity Schedule  A graphical depiction of a company’s

investment opportunities ordered highest to lowest expected return.

from

Investment Opportunity Schedule PROJECT

COST

ANNUAL INFLOWS

PROJECT LIFE (years)

ICOUNT RATE AT WHICH NPV=0

A

$200,000

$54,100

5

11%

B

150,000

32,850

7

12%

C

250,000

41,550

10

10.5%

D

350,000

87,600

6

13%

E

200,000

39,550

8

11.5%

F

250,000

105,000

3

12.5%

D = 13% 13.0 % F = 12.5% 12.5 B=12%

12

MCC

E=11.5%

11.5 11.3

A=11% 10.8

C=10.5%

250

500

Optimal Cash Budget: 950,000

750

1,000

1,250

Dollars of the new capital raised an invested during the year

IOS