At the time of developing the concept of cost of capital, you have assumed that the risk profile and financing policy of the firm do not change. Now, the question that arises is if these assumptions hold, does the weighted average cost of capital remains unchanged irrespective of the magnitude of financing? Normally, It does not. Then the WACC increases with the level of financing required. The supplies of capital generally require a higher return as they supply more capital. A schedule showing the relationship between additional financing and the weighted average cost of capital is referred as the weighted marginal cost of capital schedule.
The following steps are to be followed for determining the weighted marginal cost of capital schedule:
- The cost of each individual source of finance for various levels of usage has to be estimated.
- Given the ratio of different sources of finance in the new capital structure. Find out the levels of total new financing at which the cost of various sources would change. These levels called breaking points, can be found out as: =
- Total new financing from that source at the breaking point Proportion of that financing source in the capital structure
- Calculate the weighted average cost of capital for various ranges of total financing between the breaking points.
- List out the weighted average cost of capital for each level of total new financing. This is the weighted marginal cost of capital schedule.
