Barbarita’s Linens want to expand into the store next door to set up a Baby Supp

Question

Barbarita’s Linens want to expand into the store next door to set up a Baby Supply Store. She needs $150,000 for the build out and new inventory of the project.

Barbarita has a $250,000 line of credit from Hialeah National bank that is fully available at an interest rate of 6 percent.   $1,000,000 in equity with a cost of 3 percent. The Barbarita’s Linens just cancelled the $600,000 in preferred stock to Tia Olga, which paid an annual dividend of 10%. The companies’ tax rate is 30%.

a) Calculate the WACC.

b) Please explain this situation in words. How much will the expansion cost in annual interest? Explain your logic.

Explanation / Answer

a. Cost of Line of Credit (Post tax) = 6 (1-0.30)

= 4.2%

Cost of Equity = 3%

Cost of Preference shares = 10%

WACC = [Cost of line of credit x Weight of line credit] + [Cost of Equity x weight of equity] + [Cost of preference shares x weight of preference shares]

= [4.2 x 250000 / 1850000] + [3 x 1000000 / 1850000] + [10 x 600000 / 1850000]

= 5.43%

b. The WACC of the company is presently 5.43% that means the company incurs $0.0543 interest cost on every $1 invested in business.

Expansion cost in annual interest = 150000 x 5.43%

= $8145

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