Klose Outfitters Inc. believes that its optimal capital structure consists of 60
ID: 2779540 • Letter: K
Question
Klose Outfitters Inc. believes that its optimal capital structure consists of 60% common equity and 40% debt, and its tax rate is 40%. Klose must raise additional capital to fund its upcoming expansion. The firm will have $2 million of retained earnings with a cost of rs = 14%. New common stock in an amount up to $10 million would have a cost of re = 17%. Furthermore, Klose can raise up to $4 million of debt at an interest rate of rd = 9%, and an additional $6 million of debt at rd = 12%. The CFO estimates that a proposed expansion would require an investment of $4.6 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places.
Explanation / Answer
Total amount required = 4,600,000
Amount raised from equity = 4,600,000 x60% = 2,760,000
Amount raised from debt = 4,600,000 x60% = 1,840,000
Firm already have 2 million of retained earnings, so they need to raise 760,000from common stock and 1,840,000 from debt:
After tax cost of debt = 9% x (1-0.40) = 5.40%
Cost of RE = 14%
Cost of common stock=17%
Total cost of financing = 2,000,000x0.14 + 760,000x0.17 + 1,840,000x0.054
=508,560
WACC =Total cost of financing/ Total amount raised
= 508,560/ 4,600,000
=11.06%
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