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For your company you need to raise $ 4 M. You estimate existing equity to be $ 1 M. If you issue $ 4 M

For your company you need to raise $ 4 M. You estimate existing equity to be $ 1 M. If you issue $ 4 M of equity (so the total equity will be $ 5M), then the required cost of equity will be 16%. Alternatively you can issue a combination of equity and debt. Your bank gave you the following quote for different levels of debt (see below). Your tax rate is 35%

a) Please estimate WACC for each level of debt

b) How much money should you borrow?

c) Why is the debt interest rate increasing with amount of debt? Explain

Amount needed $ 4,000,000
Existing equity $ 1,000,000
Tax rate 35%
Cost of equity (unlevered) 16%
Interest rate table
Amount borrowed Interest rate
$ 500,000 6.00%
$ 1,000,000 7.00%
$ 2,000,000 8.00%
$ 3,000,000 10.00%
$ 4,000,000

12.00%

a) Please estimate WACC for each level of debt
Debt Equity Debt/Equity Debt/Value Interest rate After tax cost of debt Cost of equity WACC
$ - 0.00% 16%
$ 500,000 6.00%
$ 1,000,000 7.00%
$ 2,000,000 8.00%
$ 3,000,000 10.00%
$ 4,000,000 12.00%

b) How much money should you borrow?
Optimal borrowing
c) Why is the debt interest rate increasing with amount of debt? Explain

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