WACC Klose Outfitters Inc. believes that its optimal capital structure consists

Question

WACC

Klose Outfitters Inc. believes that its optimal capital structure consists of 45% common equity and 55% debt, and its tax rate is 40%. Klose must raise additional capital to fund its upcoming expansion. The firm will have $3 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 = 16%. Furthermore, Klose can raise up to $4 million of debt at an interest rate of rd = 11%, and an additional $3 million of debt at rd = 12%. The CFO estimates that a proposed expansion would require an investment of $6.8 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places.

%

Explanation / Answer

5.9 million expansion

45% equity=45%*5.9=2.655 million

3 million retianed earnings

So new equity must not be raised

hence, cost of equity=cost of retianed earnings=14%

55% debt=55%*5.9=3.245 million

This can be raised @11%

WACC=0.45*14%+0.55*11%*(1-40%)=9.93%

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