Klose Outfitters Inc. believes that its optimal capital structure consists of 70

Question

Klose Outfitters Inc. believes that its optimal capital structure consists of 70% common equity and 30% debt, and its tax rate is 40%. Klose must raise additional capital to fund its upcoming expansion. The firm will have $1 million of retained earnings with a cost of rs = 12%. New common stock in an amount up to $10 million would have a cost of re = 14%. Furthermore, Klose can raise up to $4 million of debt at an interest rate of rd = 11%, and an additional $5 million of debt at rd = 12%. The CFO estimates that a proposed expansion would require an investment of $3.8 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places.

Explanation / Answer

since 70% comes from equity

amount of equity = 3.8 * 70% = 2.66million

amount of debt = 3.8 - 2.66 = 1.14 million

1 million comes from retained earnings and 1.66 million from common stock and 1.14 million comes from debt at interest rate of 11%

weighted cost of capital

= (1/3.8) * 12% + (1.66/3.8) * 14% + (1.14/3.8) * 11%

= 12.57%

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