Question

Olsen Outfitters Inc. believes that its optimal capital
structure consists of 70% common equity and 30% debt, and its tax
rate is 40%. Olsen must raise additional capital to fund its
upcoming expansion. The firm will have $1 million of retained
earnings with a cost of r_{s} = 15%. New common stock in an
amount up to $10 million would have a cost of r_{e} = 19%.
Furthermore, Olsen can raise up to $4 million of debt at an
interest rate of r_{d} = 11% and an additional $4 million
of debt at r_{d} = 12%. The CFO estimates that a proposed
expansion would require an investment of $8.6 million. What is the
WACC for the last dollar raised to complete the expansion? Round
your answer to two decimal places.

Answer #1

Final answer

WACC = 14.81 %

**Explanation**

Total Investment = 8.60 million. Sources of financing this Investment comprises of 30% Debt = 8.6 * 0.30 = 2.58 million.

This debt amount is lower than 4 million, hence cost of debt = 11%. After tax rd = 11*(1-0.40) = 6.60 %

Retained earnings will be used = 1 million. Thus new common stock = 8.60 * 0.70 - 1 million = 5.02 millions and cost of equity (re) = 19%

**Calculation of WACC**

Amount | Weight | K | K*W | |

Common stock | 5.02 | 0.583721 | 19 | 11.0907 |

Retained earnings | 1 | 0.116279 | 15 | 1.7442 |

Debt | 2.58 | 0.3 | 6.6 | 1.98 |

8.6 |
WACC |
14.81 |

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structure consists of 70% common equity and 30% debt, and its tax
rate is 25%. Olsen must raise additional capital to fund its
upcoming expansion. The firm will have $4 million of retained
earnings with a cost of rs = 10%. New common stock in an
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