Question

Ch 10: End-of-Chapter Problems - The Cost of Capital Q Search this course o < Back to Assignment 0 x Attempts: Keep the Highest: /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 70% common equity and 30% debt, and its tax rate is 40%. Olsen must raise additional capital to fund its upcoming expansion. The firm will have $1 million of retained earnings with a cost of rs - 14%. New common stock in an amount up to $7 million would have a cost of re-17%. Furthermore, Olsen can raise up to $3 million of debt at an interest rate of 10% and an additional $6 million of debt at ra = 11%. The CFO estimates that a proposed expansion would require an investment of $9.0 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places. Grade It New Save Continue Continue without saving

Answer 1

The WACC is computed as shown below:

Total amount to be raised = $ 9 Million

Equity will be as follows:

=0.7 x  $ 9 Million

= $ 6.3 Million

$ 1 Million at 14%, next 5.3 Million at 17%

Debt (30%) = 0.3 x $ 9 Million = $ 2.7 Million

2.7 Million at 11%. After tax cost of debt =11% x (1-0.4) = 6.6%

WACC will be as follows:

= $ 1 million / $ 9 million x 14% + $ 5.3 million / $ 9 million x 17% + $ 2.7 million / $ 9 million x 6.6%

= 13.55% Approximately

WACC for the last dollar raised to complete the expansion will be

= 13.55%

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