Klose Outfitters Inc. believes that its optimal capital structure consists of 55
ID: 2669050 • Letter: K
Question
Klose Outfitters Inc. believes that its optimal capital structure consists of 55% common equity and 45% debt, and its tax rate is 40%. Klose must raise additional capital to fund its upcoming expansion. The firm will have $1 million of new retained earnings with a cost of rs = 13%. New common stock in an amount up to $7 million would have a cost of re = 16%. Furthermore, Klose can raise up to $3 million of debt at an interest rate of rd = 9%, and an additional $6 million of debt at rd = 10%. The CFO estimates that a proposed expansion would require an investment of $3.4 million. What is the WACC for the funds Klose will be raising? Round your answer to two decimal places.
______ %
Explanation / Answer
If the investment requires $3.4 million that means that it requires $1.87 million (55% x $3,400,000) of common equity and $1.53 million (45% x $3,400,000) of debt. In this case the firm would exhaust its $1 million of retained earnings and is forced to raise new common stock at a cost of 16%. Needing $1.53 million in debt, the firm could raise the debt at only 9% Calculating the WACC: The formula for calculating the WACC is WACC = [Wd x Rd x (1-T)] + (We x Re) = [0.45 * 0.09 * (1 - 0.40)] + (0.55 * 0.16) = 0.0243 + 0.088 = 0.1123 or 11.23% Therefore, the WACC is 11.23%Related Questions
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