Klose Outfitters Inc. believes that its optimal capital structure consists of 50

Question

Klose Outfitters Inc. believes that its optimal capital structure consists of 50% common equity and 50% 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 $7 million would have a cost of re = 16%. Furthermore, Klose can raise up to $4 million of debt at an interest rate of rd = 10%, and an additional $6 million of debt at rd = 12%. The CFO estimates that a proposed expansion would require an investment of $3.0 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places.

Explanation / Answer

For the $3 million new investment, given the capital structure ratio of 50-50, Klose should use 1.5 million equity and 1.5 million debt.

1.5 million equity will come from 1 million retained earnings at rs=12% and remaining 0.5 million new common stock at re=16%

1.5 million debt will come at rd=10%*(1-40%) = 6%

So WACC = 1/3*12% + 0.5/3*16% + 1.5/3*6% = 9.67%

Hope this helped ! Let me know in case of any queries.

Related Questions

Navigate

• Browse (All)
• Browse K
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.