Question
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
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 30%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed in the data given:
. 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 6% and matched this with an additional $20 million of equity, additional debt beyond this amount would cost 11% 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 in the debt market at the same time.
b. If WestGas plans an expansion of only $60 million, how should that expansion be financed?
c. What will be the weighted average cost of capital for the expansion?
\begin{tabular}{lcccc} Costs of Raising Capital in the Market & Cost of Domestic Equity & Cost of Domestic Debt & Cost of European Equity & European Debt \\ \hline Up to $40 million of new capital & 13% & 8% & 14% & 6% \\ $41 million to $80 million of new capital & 18% & 11% & 16% & 10% \\ Above $80 million & 21% & 15% & 23% & 17% \\ \hline \end{tabular} \begin{tabular}{lcccc} Costs of Raising Capital in the Market & Cost of Domestic Equity & Cost of Domestic Debt & Cost of European Equity & European Debt \\ \hline Up to $40 million of new capital & 13% & 8% & 14% & 6% \\ $41 million to $80 million of new capital & 18% & 11% & 16% & 10% \\ Above $80 million & 21% & 15% & 23% & 17% \\ \hline \end{tabular}Step by Step Solution
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