1. Axelon Corporation is a worldwide leader in oil and gas production which is based in Venezuela. The company has grown really fast during the last 10 years. The companys operations in Caracas have been so significant that it needs to construct a natural gas gath- ering and processing center at an estimated cost of $70 million.

Axelon has 20 millions of retained earnings that can be used to finance a proportion of the expansion and plans to sell a bond issue to raise the remaining $50 million. The decision to use so much debt financing for the project was largely due to the argument by company CEO (John Peterson Sr.) that debt financing is relatively cheap relative to common stock (which the firm has used in the past).

Company CFO Bob Wilmen did not object to the decision to use all debt but pondered the issue of what cost of capital to use for the expansion project. There is no doubt but that the out-of-pocket cost of financing was equal to the new interest that must be paid on the debt. However, the CFO also knew that by using debt for this project the firm would eventually have to use equity in the future if it wanted to maintain the balance of debt and equity it had in its capital structure and not become overly dependent on borrowed funds.

The following balance sheet reflects the mix of capital sources that Axelon has used in the past. Although the percentages would vary over time, the firm tended to manage its capital structure back toward these proportions:

Source of Financing	Target Capital structure Weights
Bonds	40%
Common Stocks	60%

The firm currently has one issue of bonds outstanding. The bonds have a par value of $1,000 per bond, carry an 8 percent coupon rate of interest, have 16 years to maturity, and are selling for $1,035.

Axelons common stock has a current market price of $35 and the firm paid a $2.50 dividend last year that is expected to increase at an annual rate of 6 percent for the foreseeable future.

1. If the flotation cost is $30 per bond and the tax rate is 34%, yield to maturity is 7.61%, what is the cost of new debt financing based on current market prices after taxes? (You can use the rate formula in excel to find K_d)
2. What is the investors required rate of return for Axelons common stock?
3. If Axelon were to sell new shares of common stock, it would incur a cost of $2.00 per share. What is your estimate of the cost of new equity financing raised from the sale of common stock?
4. Compute the WACC for Axelons investment using the weights reflected in the actual financing mix which is $20 million in retained earnings and $50 million in bonds.
5. Compute the WACC for Axelon where the firm maintains its target capital structure by reducing its debt offering to 40 percent of the $70 million in new capital, or $28 million, using $20 million in retained earnings and raising $22 million through a new equity offering.
6. If you were the CFO for the company, would you prefer to use the calculation of the cost of capital in part (d) or (e) to evaluate the new project? Why?