After reading this article you will learn about the Computation of Marginal Cost of Capital.
Sometimes, we may be required to calculate the cost of additional funds to be raised, called the marginal cost of capital. The marginal cost of capital is the weighted average cost of new capital calculated by using the marginal weights. The marginal weights represent the proportion of various sources of funds to be employed in raising additional funds.
In case, a firm employs the existing proportion of capital structure and the component costs remain the same the marginal cost of capital shall be equal to the weighted average cost of capital. But in practice, the proportion and/or the component costs may change for additional funds to be raised.
Under this situation, the marginal cost of capital shall not be equal to the weighted average cost of capital. However, the marginal cost of capital concept ignores the long-term implications of the new financing plans, and thus, weighted average cost of capital should be preferred for maximisation of shareholder’s wealth in the long-run.
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Illustration 1:
A firm has the following capital structure and after-tax costs for the different sources of funds used:
(a) Calculate the weighted average cost of capital using hook-value weights.
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(b) The firm wishes to raise further Rs. 6,00,000 for the expansion of the project as below
Assuming that specific costs do not change, compute the weighted marginal cost of capital.
Solution:
