Question: westgas conveyance inc is a large us natural gas pipeline...
Question details
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 40%. WestGas finds that it can finance in the domestic U.S. capital market at the rates listed below. 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 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? What will be the weighted average cost of capital for the expansion?
Rates:
|
Cost of Domestic Equity |
Cost of Domestic Debt |
Cost of European Equity |
Cost of European Debt |
|
|
Up to $40 million of new capital |
12% |
7% |
13% |
5% |
|
$41 million to $80 million of new capital |
17% |
11% |
15% |
10% |
|
Above $80 million |
23% |
15% |
24% |
16% |
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