A new cross-country, trans-mountain water pipeline needs to be built at an estimated first cost of $200,000,000. The consortium of cooperating companies has not fully decided the financial arrangements of this adventurous project. The WACC for similar projects has averaged 10% per year. (a) Two financing options have been identified. The first requires an investment of 60% equity funds at 12% and a loan for the balance at an interest rate of 9% per year. The second option requires only 20% equity funds and the balance obtained by a massive international loan estimated to carry an interest rate of 12.5% per year, which is, in part, based on the geographic location of the pipeline. Which financing plan will result in the smaller average cost of capital? (b) If the consortium CFOs have decided that the WACC must not exceed the 5-year historical average of 10% per year, what is the maximum acceptable loan interest rate for each financing option?
A new cross-country, trans-mountain water pipeline
needs to be built at an estimated first cost of
$200,000,000. The consortium of cooperating companies
has not fully decided the financial arrangements
of this adventurous project. The WACC for
similar projects has averaged 10% per year. (a) Two
financing options have been identified. The first requires
an investment of 60% equity funds at 12%
and a loan for the balance at an interest rate of 9%
per year. The second option requires only 20% equity
funds and the balance obtained by a massive
international loan estimated to carry an interest rate of 12.5% per year, which is, in part, based on the
geographic location of the pipeline. Which financing
plan will result in the smaller average cost of
capital? (b) If the consortium CFOs have decided
that the WACC must not exceed the 5-year historical
average of 10% per year, what is the maximum acceptable
loan interest rate for each financing option?
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