Olsen Outfitters Inc. believes that its optimal capital structure consists of 65

Question

Olsen Outfitters Inc. believes that its optimal capital structure consists of 65% common equity and 35% debt, and its tax rate is 40%. Olsen 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, Olsen can raise up to $3 million of debt at an interest rate of rd = 10% and an additional $3 million of debt at rd = 13%. The CFO estimates that a proposed expansion would require an investment of $6.0 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places.

Explanation / Answer

Amount raised through equity 65% of 6 million Amount raised through equity 3.90 cost of equity upto 2 million that is 33.33% of 6 million will be Ke=14% cost of equity for 1.9million that is 31.66% of 6 million will be Ke=17% Amount raised through debt 35% of 6 million 2.1 cost of debt upto 3 million 10% WACC=Ke×We+Kd×Wd×(1-tax rate) WACC=14×.3333+17×.316666+10×.35×(1-.4) WACC= 12.15%

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