roblem 13-6 (algorithmic)

WestGas Conveyance, Inc. 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 32%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed in the popup window: LOADING.... 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 50% by debt and 50% by equity.

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.

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 5% and matched this with an additional $20 million of equity, additional debt beyond this amount would cost 13% in the United States and 12% 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 in the debt market at the same time.

b. If WestGas plans an expansion of only $60 million, how should that expansion be financed? What will be the weighted average cost of capital for the expansion?

Costs of Raising Capital in the Market	Cost of domestic equity	cost of domestic debt	cost of european equity	cost of european debt
Up to $40 million of new capital	13%	8%	14%	7%
$41 million to $80 million of new capital	18%	11%	16%	9%
Above $80 million	23%	17%	25%	19%