Question

< Back to Assignment Attempts: 0 Keep the Highest: 0/1 10. Problem 10.10 Click here to read the eBook: Basic Definitions WACC Olsen Outfitters Inc. believes that its optimal capital structure consists of 65% common equity and 35% debt, and its tax rate is 40%. Olsen must raise additional capital to fund its upcoming expansion. The firm will have $2 million of retained earnings with a cost of rs = 13%. New common stock in an amount up to $9 million would have a cost of re-15%. Furthermore, Olsen can raise up to $4 million of debt at an interest rate of ra -9% and an additional $3 million of debt atra -11%. The CFO estimates that a proposed expansion would require an investment of $6.6 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places. Save come Continue without saving

Answer 1

In the given question, there are multiple gears
	Limits (in millions)	Cost
Cost of retained earnings	$                     2.00	13.00%
Cost of new equity	$                     9.00	15.00%
Cost of the first debt	$                     4.00	9.00%
Cost of 2nd debt	$                     3.00	11.00%
Now let's assess the total requirement of $ 6.6 million
Target capital structure
Equity	65%
Debt	35%
New project funding
Equity=	6.6*65%	4.29
Debt=	6.6-4.29	2.31
Equity of $ 4.29 million will be sourced as follows. $ 2 million from retained earnings and
rest $ 2.29 million will be sourced from new equity. The debt of $ 2.31 million will be sourced
from first debt as the first debt limit is $ 4 million
Calculation of after-tax cost of debt
Cost of debt	9%
Tax rate	40%
After-tax cost of debt	=9%*(1-40%)
After-tax cost of debt	5.40%
Calculation of WACC
	Cost	Capital		Weight	Weighted cost
	A	B	Weight	C=Capital component/Total capital	D=A*C
Debt	5.40%	$         2.31	=2.31/6.6	35.00%	1.89%
Retained earnings	13.00%	$         2.00	=2/6.6	30.30%	3.94%
Equity	15.00%	$         2.29	=2.29/6.6	34.70%	5.20%
	Total capital	$         6.60		Total WACC	11.03%