Question

Consider the following current capital structure and two potential variations to the capital structure for KLM Corporation:

	Current	Financial Mix 1	Financial mix 2
Proportion of debt	50%	40%	60%
Proportion of equity	50%	60%	40%
Pre-Tax cost of debt	5.25	5.0%	5.5%
Cost of equity	7.9%	7.5%	8.3%
Corporate tax rate 30%

(a) Calculate the weighted average cost of capital for KLM Corporation under the three separate capital structures, i.e. Current, Mix 1 and Mix 2. Write your answers up to 4 decimal places of accuracy, e.g. 15.6789% is good, whereas 15.68% is not.

	Current	Financial Mix 1	Financial Mix 2
Weighted average cost of capital (rWACC)

i. Which of the three capital structures provides an optimal financing mix: __________________

ii. What is the WACC at the optimal capital structure? ____________________

(b) Consider the same problem except that now the firm pays only 9% corporate tax rate. Calculate the weighted average cost of capital for KLM Corporation under the three separate capital structures, i.e. Current, Mix 1 and Mix 2. Write your answers up to 4 decimal places of accuracy, e.g. 15.6789% is good, whereas 15.68% is not.

	Current	Financial Mix 1	Financial Mix 2
Weighted average cost of capital (rWACC)

i. Which of the three capital structures provides an optimal financing mix: __________________

ii. What is the WACC at the optimal capital structure? ____________________

Answer 1

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09:47 W ' v aux 3 ENG E. 19-03-2020 ... o X A1293 AI AJ AK AL AM AN AO AP AQ A 292 AFTER TAX COST OF DEBT = 5.25%*(1-0.30) = 3.6750% 293 294 295 296 WACC BASED ON CURRENT STRUCTURE SOURCE WEIGHTS 297 298 A WEIGHTED COST A*B 1.8375% 3.9500% COC(%) B 3.6750% 7.90% 299 DEBT EQUITY 50% 50% 300 301 WACC = 5.7875% 302 303 304 305 AFTER TAX COST OF DEBT = 5.00%*(1-0.30) = 3.5000% 306 307 WACC BASED ON MIX 1 SOURCE WEIGHTS COC(%) 308 309 310 311 312 313 WEIGHTED COST A*B 1.4000% 4.5000% DEBT EQUITY 40% 60% 3.5000% 7.50% WACC = 5.9000% 314 315 ... CoNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PORTFOLOQ DIR right clean YIELD bond portfolio WACC RESI DIV POLI ... +

W © v to a dx 3 ENG 09:49 19-03-2020 ... o X AJ336 Al AS AK AL AM AN AO AP AQ AFTER TAX COST OF DEBT = 5.5%*(1-0.30) = 3.8500% 316 317 318 319 320 WACC BASED ON MIX 2 321 SOURCE coc(%) В 322 323 WEIGHTS А 60% 40% WEIGHTED COST A*B 2.3100% 3.3200% 324 DEBT EQUITY 3.8500% 8.30% 325 WACC = 5.6300% 326 327 328 329 CURRENT 5.7875% MIX 1 5.9000% MIX 2 5.6300% WACC 330 331 332 333 OPTIMAL FINANCING MIX IS : FINANCIAL MIX 2 WACC AT OPTIMAL CAPITAL STRUTURE LOWEST WACC 5.6300% 334 335 336 337 338 339 ... CoNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PORTFOLOQ DIR right clean YIELD bond portfolio WACC RESI DIV POLI ... +

W ©v to a dx 3 ENG 09:52 = 19-03-2020 ... o X A1347 ALAJ AK AL AM AN AO AP AQ A AFTER TAX COST OF DEBT = 5.25%*(1-0.09) = 4.7775% 337 338 PART b 339 340 341 342 343 WACC BASED ON CURRENT STRUCTURE SOURCE WEIGHTS 344 COC(%) B 4.7775% 7.90% WEIGHTED COST A*B 2.3888% 3.9500% DEBT EQUITY 50% 50% WACC = 6.3388% AFTER TAX COST OF DEBT = 5.00%*(1-0.09) = 4.5500% 345 346 347 348 349 350 351 352 353 354 355 356 357 358 359 360 201 WACC BASED ON MIX 1 SOURCE WEIGHTS COC(%) A WEIGHTED COST A*B 1.8200% 4.5000% DEBT EQUITY 40% 60% 4.5500% 7.50% WACC = 6.3200% ... CoNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PORTFOLOQ DIR right clean YIELD bond portfolio WACC RESI DIV POLI ... +

W © v to a dx 3 ENG 09:53 19-03-2020 ... o X AJ382 X fic ALAJ AK AL AM AN AO AP AQ A 361 362 363 AFTER TAX COST OF DEBT = 5.5%*(1-0.09) = 5.0050% 364 365 WACC BASED ON MIX 2 366 SOURCE WEIGHTS 367 368 369 COC(%) B WEIGHTED COST A*B DEBT 60% 5.0050% 3.0030% 370 EQUITY 40% 8.30% 3.3200% 371 WACC = 6.3230% 372 373 374 375 376 377 CURRENT 6.3388% MIX 1 6.3200% MIX 2 6.3230% WACC 378 379 380 OPTIMAL FINANCING MIX IS : FINANCIAL MIX 1 WACC AT OPTIMAL CAPITAL STRUTURE LOWEST WACC 6.3200% 381 382 383 ... CoNvexity DGM beta port future INDEX INTL CAP BUD SANDRINE LEASING PORTFOLOQ DIR right clean YIELD bond portfolio WACC RESI DIV POLI ... +