Question

Monica is the CFO of Cooking for Friends​ (CFF) and uses the pecking order hypothesis philosophy when she raises capital for company projects. ​ Currently, she can borrow up to ​$400,000 from her bank at a rate of 7.5​%, float a bond for ​$800,000 at a rate of 9.5​%, or issue additional stock for ​$1,500,000 at a cost of 17​%. What is the WACC for CFF if Monica chooses to invest

a.​$1,000,000 in new​ projects?

b.​$2,200,000 in new​ projects?

c.​$2,700,000 in new​ projects?

What is the WACC for CFF if Monica chooses to invest ​$1 ,000,000 in new​ projects?

Answer 1

Since Bank loan cost lowest it shall be given first preference than bonds should be given preference and lastly equity

a) If she needs $1000000

Statement showing WACC

Source of funds	Amount	Weight	Cost of capital =K	WACC = Weight*K
Bank loan	400,000	40%	7.50%	3.00%
Bonds	600,000	60%	9.50%	5.70%
	1,000,000			8.70%

b) if she needs 2200,000$

Source of funds	Amount	Weight	Cost of capital =K	WACC = Weight*K
Bank loan	400,000	18%	7.50%	1.36%
Bonds	800,000	36%	9.50%	3.45%
Equity	1,000,000	45%	17.00%	7.73%
	2,200,000			12.55%

c) if she needs 2700,000$

Source of funds	Amount	Weight	Cost of capital =K	WACC = Weight*K
Bank loan	400,000	15%	7.50%	1.11%
Bonds	800,000	30%	9.50%	2.81%
Equity	1,500,000	56%	17.00%	9.44%
	2,700,000			13.37%