Sources of Capital

Most companies have several types and sources of capital. BlueVal has both equity and debt in its capital structure, each costing a different amount. When companies make capital investment decisions, it is useful to compute theweighted average cost of capitalconsidering all the capital sources that the company employs.

After financing the expansion, 60 percent of BlueVal's capital equity has an estimated cost of 22.5 percent. 40 percent of BlueVal's capital comes from debt, with half at an interest rate of 10 percent (mortgage rate) and half at 8 percent for the proposed new line of credit. The cost of debt is lower than expected because of the 34 percent expected tax savings.

The following table illustrates BlueVal's capital structure?pre and post financing:

Capital Sources and Structures BlueVal decides on an expansion strategy; however. senior management realizes that they do not have enough cash on hand to nance a major expansion of the business. Nonetheless, they do have a very good balance sheet with a solid debt-to-equity ratio. After a preliminary analysis of current cash ows, it shows that BlueVal will need $2 million for additional property as well as plant and equipment in addition to more working capital to finance any type of expansion. Being on good terms with the local bank was a good strategy on Lisa, Angelo. and Jason's part. As a re5ult, they believe that they should not have any trouble securing and carrying additional debt. In addition, venture capital investors have also expressed an interest in purchasing more stock in BlueVal if the price is right. More Debt for BlueVal? In an unstable business environment, banks will not lend unless they are almost positive that businesses will be able to repay the loan, and this applies to BlueVal as well. The amount of equity capital (stock) in a business acts as a safety cushion for the bank. The stockholders will lose everything before the bank would lose anything. Generally, debt is a cheap form of financing if the company has access to it. BlueVal's Debt Cost Therefore, what will bank nancing actually cost BlueVal? The local bank sets its interest rate by two components. They add the current risk free lending return from government bonds to risk premium based on how risky they judge the company to be. For example, if government bonds are yielding 2.3 percent and the loan ofcer sees BlueVal as a moderate risk and underscores 3 percent risk, then BlueVal's total interest rate will be 5.3 percent. More Equity for BluVal Lisa, Jason, and Anglo meet with their friendly venture capitalist, Suzie Bucks, who fully Supports BlueVal's expansion plans. She is willing to buy more stock and will invest an additional $80,000 at a pre-money valuation of $2.5 million and thus a post-money valuation of $3.3 million. The team does not completely understand these terms. They return to the rm and contact their chief nance ofcer to nd out exactly what Suzie Bucks is suggesting. Capital Transaction as of Proposed New Total After New December 31, Financing (In US Financing (In US 201 O (In US Dollars) Dollars) Dollars) ___ ___