You are the CFO of Megatron Industries. You have $53.9 million in LTD, $7.7 in p

Question

You are the CFO of Megatron Industries. You have $53.9 million in LTD, $7.7 in preferred stock and $15.4 million in common equity. The weights for the current capital structure are 70% debt, 10% preferred, 20% common equity. You are considering a major project which would add $23 million to the capital structure: Structure A: $70 million LTD, $10 million preferred, $20 million common Structure B: $53.9 million LTD, $7.7 million preferred, $38.4 million common Structure C: $ 53.9 million LTD, $ $30.7 million preferred, $15.4 million common Cost: Current structure: 2.9% debt, .54% preferred stock, and 6.46% equity New structure: 2.12% debt, 1.09% preferred, 7.2% equity Determine which structure is best and defend your response.

Explanation / Answer

Best structure has the least WACC WACC with current structure = 70%*2.9% + 10%*.54%+ 20%*6.46% =3.38% WACC with Structure A = 70/(70+10+20)*2.12% + 10/(70+10+20)*1.09% + 20/(70+10+20)*7.2% =3.03% WACC with Structure B= 53.9/(53.9+7.7+38.4)*2.12% + 7.7/(53.9+7.7+38.4)*1.09% + 38.4/(53.9+7.7+38.4)*7.2% =3.99% WACC with Structure C = 53.9/(53.9+30.7+15.4)*2.12% + 30.7/(53.9+30.7+15.4)*1.09% + 15.4/(53.9+30.7+15.4)*7.2% = 2.59% Structure C has the lowest WACC and hence Structure C is the best structure

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