Olsen Outfitters Inc. believes that its optimal capital structure consists of 60
ID: 2801534 • Letter: O
Question
Olsen Outfitters Inc. believes that its optimal capital structure consists of 60% common equity and 40% debt, and its tax rate is 40%. Olsen must raise additional capital to fund its upcoming expansion. The firm will have $3 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 = 15%. Furthermore, Olsen can raise up to $3 million of debt at an interest rate of rd = 10% and an additional $4 million of debt at rd = 11%. The CFO estimates that a proposed expansion would require an investment of $6.9 million. What is the WACC for the last dollar raised to complete the expansion? Round your answer to two decimal places.
Explanation / Answer
Total capital = 6.9m
Total equity = 60% x 6.9m = 4.14m, of which 3m in retained earnings and 1.14 in new common stock
Total debt = 40% x 6.9 = 2.76 million
WACC = we x ke + wd x kd x (1 - tax)
= 3 / 6.9 x 12% + 1.14 / 6.9 x 15% + 2.76 / 6.9 x 10% x (1 - 40%)
= 10.10%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.