Benchmark has an optimal target capital structure consisting of a debt-to-assets ratio of 60 percent.   Benchmark can raise up to $5 million in new debt at a before-tax cost of 8 percent. If more debt is required, the initial cost will be 8.5 percent, and if more than 10 million in debt is required, the cost will be 9 percent.  Net income for the previous year was $10 million, and is expected to increase by 10 percent this year.  Benchmark expects to maintain its dividend payout ratio of 40 percent on the 1 million shares of common stock outstanding.  If it must sell new common stock, it would encounter a 10 percent flotation cost on the first $2 million, an 15 percent cost if more than $2 million but less than $4 million is needed, and a 20 percent cost if more than $4 million of new equity is required.  Benchmark's tax rate is 30 percent, and its current stock price is $88 per share.  Benchmark has an unlimited number of projects that will earn a 10.25 percent return.  Untimely, Benchmark wishes to determine the maximum capital budget that can be adapted without adversely affecting stockholder wealth.

 

a.  How many break points are associated with debt, what are they in dollars, and what is the associated after-tax cost of debt for under $5 million, between $5 and $10 million, and over $10 million?

 

b.  If Benchmark does not resort to raising equity capital externally, what is the break point associated with raising funds internally and what is its cost (in percent)?

 

c.  How many break points are associated with new common stock, what are they in dollars, and what is the cost of new common stock up to the first $2 million?  Between $2 and $4 million?  Over $4 million?

 

d.  Compute the WACC associated with each of the break points previously computed.

 

e.  What is Benchmark's maximum capital budget that can be adapted without adversely affecting stockholder wealth?