1. FIN 635 Problem Set Three Please answer all the questions as completely as possible. 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 40%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed below. 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 half by equity and half by debt. US Capital Market Costs: Amount of Capital Raised Cost of Equity Cost of Debt Up to $40 million of New 12% 8% Capital $41 million to $80 million of 18% 12% New Capital Above $80 million 22% 16% 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. European capital market Costs: Amount of Capital Raised Cost of Equity Cost of Debt Up to $40 million of New 14% 6% Capital $41 million to $80 million of 16% 10% New Capital Above $80 million 24% 18% 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 6% and matched this with an additional $20 million of equity, additional debt beyond this amount would cost 12% in the United States and 10% 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 million in the debt market at the same time. a. If WestGas pans an expansion of only $60 million, how should that expansion be financed? What will be the weighted average cost of capital for the expansion? 2. Assume Nikkem Microsystems has sold Internet Servers to Telecom Espania for 700,000 euros. Payment is due in 3 months and will be made with trade acceptance from Telecom Espania Acceptance. The acceptance fee is 1.0 % per annum of the face amount of the note. This acceptance will be sold at 4% per annum. What is the annualized percentage all-in cost in euros of this method of trade financing? 3. WS is considering bidding to sell $100,000 of ski equipment to Phang Family Enterprises of Seoul, Korea. Payment would be due in 6 months. Since WS cannot find good credit information on Phang, WS wants to protect its credit risk. It is considering the following solution. Phang's bank issues a letter of credit on behalf of Phang and agrees to accept WS's draft for $100,000 due in 6 months. The acceptance fee would cost WS $500, plus reduce Phang's available credit line by $100,000. The bankers' acceptance note of $100,000 would be sold at a 2% per annum discount in the money market. What is the annualized percentage all-in cost to WS of this bankers' acceptance financing? 4. Umaru Oil of Nigeria has purchased oil drilling equipment from Gunslinger Drilling of Houston Texas. Umaru must pay for the equipment over the next 5 years at a rate of $200,000 per year due on March 1st each year. Bank of Zurich, a Swiss forfeiter, has agreed to buy the 5 notes of $200,000 each at a discount. The discount rate would be approximately 8% per annum based on the expected 3-year LIBOR rate plus 200 basis points, paid by Umaru Oil. Bank of Zurich also would charge Umaru Oil an additional fee of 2% per annum from the date of its commitment to finance until receipt of the actual discounted notes issued in accordance with the financing contract. The $200,000 promissory notes will come due on March 1st in successive years. The promissory notes issued by Umaru Oil will be endorsed by their bank, Lagos City Bank, for a 1% fee and delivered to Gunslinger Drilling. At this point Gunslinger Drilling will endorse the notes without recourse and discount them to a forfeiter, bank of Zurich, receiving the full $200,000 principal amount. Bank of Zurich will sell the notes by re-discounting them to investors in the international money market without recourse. At maturity the investors holding the notes will present them for collection at Lagos City Bank. If Lagos City Bank defaults on payment, the investors will collect the notes from Bank of Zurich. a. What is the annualized percentage all-in-cost to Umaru Oil of financing the first $200,000 note due in March 1, 2011? b. What might motivate Umaru Oil to use this relatively expensive alternative for financing?