A new cross-country, trans-mountain water pipeline needs to be built at an estimated first cost of $200,000,000. The consortium of cooperating com - panies has not fully decided the financial arrange - ments of this adventurous project. The WACC for similar projects has averaged 10% per year. (a) Two financing options have been identified. The first re - quires an investment of 60% equity funds at 12% and a loan for the balance at an interest rate of 9% per year. The second option requires only 20% eq - uity funds and the balance obtained by a massive international loan estimated to carry an interest cost of 12.5% per year. which financing plan will result in the smaller average cost of capital?

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Business

Julissa Jensen

16 October, 22:39

A new cross-country, trans-mountain water pipeline needs to be built at an estimated first cost of $200,000,000. The consortium of cooperating com - panies has not fully decided the financial arrange - ments of this adventurous project. The WACC for similar projects has averaged 10% per year. (a) Two financing options have been identified. The first re - quires an investment of 60% equity funds at 12% and a loan for the balance at an interest rate of 9% per year. The second option requires only 20% eq - uity funds and the balance obtained by a massive international loan estimated to carry an interest cost of 12.5% per year. which financing plan will result in the smaller average cost of capital?

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Allison Moore · Answer 1

The first financing plan will result in the smaller average cost of capital of 10.8%

Explanation:

In the first option:

WACC = (equity fraction) (cost of equity capital) + (debt fraction) (cost of debt capital)

= (60*12%) + (40*9%)

= 10.8%

In the second option:

WACC = (equity fraction) (cost of equity capital) + (debt fraction) (cost of debt capital)

= (20*12%) + 80*12.5%)

= 12.4%

Therefore, The first financing plan will result in the smaller average cost of capital of 10.8%