The marginal weights represent the proportion of funds the firm intends to employ. Thus, the problem of choosing between the book value weights and the market value weights does not arise in the case of marginal cost of capital computation.

Marginal Cost of Capital (MCC) Formula

MCC = (E/V) × Re + (D/V) × Rd × (1 – Tc)

E: Market value of equity

D: Market value of debt

V: Total market value of equity and debt (E + D)

Re: Cost of equity

Rd: Cost of debt 

The marginal weights represent the proportion of funds the firm intends to employ. Thus, the problem of choosing between the book value weights and the market value weights does not arise in the case of marginal cost of capital computation.

To calculate the marginal cost of capital, the intended financing proportion should be applied as weights to marginal component costs. The marginal cost of capital should, therefore, be calculated in the composite sense.

When a firm raises funds in proportional manner and the component’s cost remains unchanged, there will be no difference between average cost of capital (of the total funds) and the marginal cost of capital. The component costs may remain constant upto certain level of funds raised and then start increasing with amount of funds raised.

For example, the cost of debt may remain 7% (after tax) till Rs.10 lakhs of debt is raised, between Rs.10 lakhs and Rs.15 lakhs, the cost may be 8% and so on.

Similarly, if the firm has to use the external equity when the retained profits are not sufficient, the cost of equity will be higher because of the floatation costs. When the components cost start rising, the average cost of capital will rise and the marginal cost of capital will however, rise at a faster rate.