Final answer:
XYZ's MCC break point will occur when the $6,000,000 of low-cost debt and the equal amount of retained earnings are fully utilized, necessitating a switch to the costlier new common stock for further financing. They will run out of retained earnings, triggering the break point.
Step-by-step explanation:
The break point for XYZ's Marginal Cost of Capital (MCC) will occur when the cost-effective forms of financing are exhausted and XYZ must switch to a more expensive form of capital. Given the provided information, XYZ has a targeted capital structure (TCS) of 50% debt and 50% common equity. They can borrow up to $6,000,000 at an after-tax cost of debt of 7%. However, when they have to borrow beyond this, the cost of debt increases to 9%. Furthermore, they have $20,000,000 in retained earnings available at a cost of 12% before they need to issue new common stock at a higher cost of 16%.
The firm will experience its MCC break point when the cost-effective funds, specifically retained earnings, are depleted. Since XYZ plans to maintain a 50/50 debt-to-equity ratio, they can utilize $6,000,000 of debt at 7% and an equal amount of retained earnings. Therefore, the firm will run out of retained earnings after it has invested $12,000,000—which is the combined amount of low-cost debt and retained earnings. The next available fund source is new common stock, which has a higher cost of equity, signaling the break point. The actual break point dollar amount can be calculated based on XYZ's total financing needs and their targeted capital structure.