Thunderhorse Oil. Thunderhorse Oil is a U.S. oil company. Its current cost of debt is 7.10%, and the 10-year U.S. Treasury yield, the proxy for the risk-free rate of inte
Thunderhorse Oil. Thunderhorse Oil is a U.S. oil company. Its current cost of debt is 7.10%, and the 10-year U.S. Treasury yield, the proxy for the risk-free rate of interest, is 3.70%. The expected return on the market portfolio is 8.60%. The company’s effective tax rate is 39%. Its optimal capital structure is 75% debt and 25% equity.
a. If Thunderhorse’s beta is estimated at 1.20, what is Thunderhorse’s weighted average cost of capital?
b. If Thunderhorse’s beta is estimated at 0.70, significantly lower because of the continuing profit prospects in the global energy sector, what is Thunderhorse’s weighted average cost of capital?
Question 2
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 popupwindow:
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 12% 9% 13% 7%
$41 million to $80 million of new capital 19% 11% 18% 10%
Above $80 million 21% 16% 22% 17%
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 followingcosts, 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 7% 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.
If WestGas plans an expansion of $120 million, what is the lowest average cost of capital for the first $40 million of new capital?
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.
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?
Collepals.com Plagiarism Free Papers
Are you looking for custom essay writing service or even dissertation writing services? Just request for our write my paper service, and we'll match you with the best essay writer in your subject! With an exceptional team of professional academic experts in a wide range of subjects, we can guarantee you an unrivaled quality of custom-written papers.
Get ZERO PLAGIARISM, HUMAN WRITTEN ESSAYS
Why Hire Collepals.com writers to do your paper?
Quality- We are experienced and have access to ample research materials.
We write plagiarism Free Content
Confidential- We never share or sell your personal information to third parties.
Support-Chat with us today! We are always waiting to answer all your questions.
