Question

roblem 13-6 (algorithmic)

WestGas​ Conveyance, Inc. WestGas​ Conveyance, Inc., is a large U.S. natural gas pipeline company that wants to raise​ $120 million to finance expansion. WestGas wants a capital structure that is 50​% debt and 50​% equity. Its corporate combined federal and state income tax rate is 32​%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed in the popup​ window: LOADING.... Both debt and equity would have to be sold in multiples of​ $20 million, and these cost figures show the component​ costs, each, of debt and equity if raised 50​% by debt and 50​% by equity.

A London bank advises WestGas that U.S. dollars could be raised in Europe at the following​ costs, also in multiples of​ $20 million, while maintaining the 50​/50 capital structure.

Each increment of cost would be influenced by the total amount of capital raised. That​ is, if WestGas first borrowed​ $20 million in the European market at 5​% and matched this with an additional​ $20 million of​ equity, additional debt beyond this amount would cost 13​% in the United States and 12​% in Europe. The same relationship holds for equity financing.

a. Calculate the lowest average cost of capital for each increment of​ $40 million of new​ capital, where WestGas raises​ $20 million in the equity market and an additional​ $20 in the debt market at the same time.

b. If WestGas plans an expansion of only​ $60 million, how should that expansion be​ financed? What will be the weighted average cost of capital for the​ expansion?

Costs of Raising Capital in the Market	Cost of domestic equity	cost of domestic debt	cost of european equity	cost of european debt
Up to $40 million of new capital	13%	8%	14%	7%
$41 million to $80 million of new capital	18%	11%	16%	9%
Above $80 million	23%	17%	25%	19%

Answer 1