Brachman Builders is a large international construction firm that wants to raise

Question

Brachman Builders is a large international construction firm that wants to raise up to $30 million to finance expansion. Brachman desires to maintain a capital structure that is 50% debt and 50% equity. Brachman can finance in the domestic and international markets at the rates listed in the following table. The following cost figures show the component costs, each, of debt and equity if raised half by equity and half by debt.

Cost of Domesic Equity 10%

Cost of Domesic Debt 8%

Cost of European Equity 12%

Cost European Debt 6%

What is the lowest possible average cost of capital for Brachman if the firm raises $30 million, maintains their desired capital structure and they are in a 30% tax bracket?

ANSWERS:

A. 7.00%

B. 8.10%

C. 4.90%

D. 7.10%

Explanation / Answer

What is the lowest possible average cost of capital for Brachman if the firm raises $30 million, maintains their desired capital structure and they are in a 30% tax bracket?

Total Finance in the domestic

Average cost of capital = Cost of Equity* Weight of Equity + Cost of after tax debt* Weight of debt

Average cost of capital = 10*0.5 + 8*(1-30%)*0.50

Average cost of capital = 7.80%

Total Finance in the International

Average cost of capital = Cost of Equity* Weight of Equity + Cost of after tax debt* Weight of debt

Average cost of capital = 12*0.5 + 6*(1-30%)*0.50

Average cost of capital = 8.10%

Lowest possible average cost of capital use of mix of domestic & International

Average cost of capital = Cost of Equity* Weight of Equity + Cost of after tax debt* Weight of debt

Average cost of capital = 10*0.5 + 6*(1-30%)*0.50

Average cost of capital = 7.10%

Answer

Lowest possible average cost of capital = 7.10%

D. 7.10%

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