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16 May, 09:06

Klose outfitters inc. believes that its optimal capital structure consists of 60% common equity and 40% debt, and its tax rate is 40%. klose must raise additional capital to fund its upcoming expansion. the firm will have $2 million of new retained earnings with a cost of rs = 12%. new common stock in an amount up to $6 million would have a cost of re = 15%. furthermore, klose can raise up to $3 million of debt at an interest rate of rd = 10% and an additional $4 million of debt at rd = 12%. the cfo estimates that a proposed expansion would require an investment of $5.9 million. what is the wacc for the last dollar raised to complete the expansion?

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  1. 16 May, 10:38
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    Total amount to be raised = 5.9 Million

    Equity (60%) = 0.6 * 5.9 Million = 3.54 Million

    2 Million at 12%, next 1.54 Million at 15%

    Debt (40%) = 0.4*5.9 Million = 2.36 Million

    2.36 Million at 10%. After tax cost of debt = 10% * (1-0.4) = 6%

    WACC = 2/5.9*12% + 1.54/5.9*15% + 2.36/5.9*6% = 10.38%

    WACC for the last dollar raised to complete the expansion = 10.38%
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