Capital Structure

The capital structure of a firm describes the compositions of equity and debt that
organizations use to finance their operations and for the purchase of assets. The composition of
equity and debt is essential because it is used to evaluate many company aspects, such as
financial ratios and for capital budgeting evaluations and computation. Therefore, this paper
analyzes Apex’s printing capital structure and includes computations of the weighted average
cost of capital (WACC) to enable the organization to make a capital decision.
An organization’s capital is made up of debt and equity. Equity includes common stock and
retained earnings, and debt includes notes payable, and the long-term debt in the company. As
such, the company’s capital structure can change depending on how it alters its composition of
debt and equity. Apex’s weights have been provided as 40% debt and 60% equity, and the cost
of debt has also been provided as 8%. The other information will be used to compute the cost of
equity using the Capital Asset Pricing Model (CAPM) using the formula Er = rf + B (rm-rf)
where:
 Rf is the risk-free rate (given as 2%)
 B is the market beta (given as 1.5)
 Rm is the expected market return (shown as 11%)
Using the above formula, the cost of equity is 15%.
Computing the WACC
The weighted average cost of capital is computed by the sum of multiplying the weight of
equity by the price of equity and the weight of debt by the cost of debt and the tax rate (Editorial
Board, 2015).

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We = 60%, Cost of Equity = 15.5%, Weight of debt = 40%, cost of debt=8%, tax rate.
(60%15.5%) +(40%8%* (1-35%) = 11.38%.
The weighted average cost of capital for Apex capital decisions is 11.38 %.
WACC and capital decisions
Apex printing may have to finance the new project through equity or debt. Each of the
sources of capital has different costs. For example, the company may choose to finance the
project through debt. The capital structure would change because it would mean that the
organization has taken up more debt, and the weight of debt would increase. Similarly, if the
company issued more common equity, the weighting would change, and such weights affect the
weighted average cost of capital.
The weighted average cost of capital represents the least return that Apex should accept
for any capital decision. This means that the investment’s Internal Rate of Return (IRR) should
be higher than the weighted average cost of capital for the decision to be accepted (Editorial
Board 2015). Capital decisions can also be evaluated if they generate multiple cashflows in the
future. The Present Net Value (NPV) formula discounts such cash flows back to the present
value, and the WACC is used as the discounting factor when calculating the net current value. In
summary, the ideal situation would be for a project’s Internal Rate of Return (IRR) to be greater
than the WACC because this means that the cost of the financing of the project, particularly the
mix of debt and equity, has been covered (Editorial Board, 2015). If the IRR exceeds the WACC,
the NPV is positive.

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The marginal cost of capital (MCC)
The marginal cost of capital is the incremental cost of capital that an organization would
have to incur to finance an additional unit of debt or equity from its sources of capital. In Apex’s
case, its sources are debt and equity. If Apex Printing needed to raise additional funds from those
sources, the extra cost it would incur would be referred to as the marginal cost of capital. As
such, Apex Printing’s marginal cost of capital would increase if the company raised more capital.
The marginal cost of capital is also comprised of two factors: the marginal cost of debt and
equity. As such, considering the additional costs, Apex printing can also compute the weighted
marginal cost of capital.
Apex printing can finance new investments through reinvesting retained earnings and
raising debt in a manner that maintains the weights at 40% and 60% in debt and equity.
However, if the expected cost of capital increases beyond the total of retained earnings and debt
or stock required to maintain the capital structure, then the marginal cost of capital increases
(Adebambo et al,2019). For this reason, the marginal cost of capital increases in steps.
The marginal cost of capital does not increase indefinitely and up to a breakpoint. A
breakpoint is defined as the new investments that the company makes without an increase in
marginal cost (Levy & Levy, 2016). When represented graphically, the breakpoint would be the
point that the marginal cost of the capital curve breaks from its flat trend.
In conclusion, Apex printing’s internal rate of return should be higher than the 11.38%
weighted average cost of capital. If investing in the project would require Apex to find additional
capital, it would have to consider the marginal cost of capital for any increase in a unit of debt or
equity.

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References

Adebambo, B., Bowen, R. M., Malhotra, S., & Zhu, P. (2019). CEO Extraversion and the Cost of
Equity Capital. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3365155

Editorial Board (2015). Global Financial Management. Words of Wisdom, LLC.
https://coloradotech.vitalsource.com/books/9781943926008
Levy, H., & Levy, M. (2016). The Marginal Cost of Capital: A Portfolio Theory Perspective.
SSRN Electronic Journal. https://doi.org/10.2139/ssrn.2736985