Corporate Finance - Cost of Capital - Break Points amount, capital, structure

wildrose

Hi,

Break point = (amount of capital at which the compnents's cost of capital changes) /
(weight of the component in the capital structure)

Why is the amount of capital divided by the weight of the component in the cap structure?

ishfaque

yes - spot on.

Matori

Oops i did not check the calculations, i assumed 5/0.4=11.25.Anyways...
do you agree with the explaination as that's what matters...

bapswarrior

oops - disregard everything in my last post after "An identical logic holds for the equity breakpoint." I forgot to check my work.

AJ: I believe you have a math error - 5/0.40 is 12.5, not 11.25 (speaking as one who also made an error)

pacmandefense

Thanks razedge.

But, I don't understand the logic of the equation;

Break point = (amount of capital at which the compnents's cost of capital changes) /
(weight of the component in the capital structure)

Why does this constitute a break point?

draz

If you capital structure is 40% debt and 60% equity, and for example you have say 5 million debt and 10 million equity available then,

your first breakpoint for debt will occur at
5/40% = 5/0.40= 11.25 million dollars

and first breakpoint for equity will occur at 10/0.6 = 16.67

JGovender

I am looking at Schweser but don't understand the logic of this...

leadcfa

breakpoint was explained very poorly in the CFAI text, but much better in schwesser notes. Check it out.