The Mason Corporation s present capital structure which is also its
The Mason Corporation’s present capital structure, which is also its target capital structure, calls for 50 percent debt and 50 percent common equity. The firm has only one potential project, an expansion program with a 10.2 percent expected return and a cost of $20 million, which is completely divisible—that is, Mason can invest any amount up to $20 million. The firm expects to retain $3 million of earnings next year. It can raise up to $5 million in new debt at a before-tax cost of 8 percent, and all debt after the first $5 million will have a before-tax cost of 10 percent. The cost of retained earnings is 12 percent, and the firm can sell any amount of new common stock desired at a constant cost of 15 percent. The firm’s marginal tax rate is 40 percent. What is the firm’s optimal capital budget?

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