hi can u give me proper answer the answer earlier is wrong 5 Problem 3 0 pts) GU

Question

hi can u give me proper answer the answer earlier is wrong

5 Problem 3 0 pts) GUMO, Inc., a leading manufacturer of Solar Panels in Carefree, Arizona, is planning to expand its operations. Using the standard financial forecasting and planning tool, the External Funds Needed (EFN), GUMO will need to raise $100 million and must decide between debt or equity financing with the attendant risk-return trade off. For the purpose of this analysis, the firm's financials are given below. The current debt ratio in the industry is 40 percent. Balance Sheet: GUMO, Inc. December 31,2017 (in thousands of dollars) ASSETS LIABILITIES Total Currents $600 Total Current Debt (10%) Long-term Debt (10 %) 5300 $300 Total Debs600 Common Stock1.00 par ....100 Paid-in-Capital Retained Earnings $100 $1,000 Income Statement December 31, 2017 (in thousands of dollars) Pro forma $2,200 2017 Sales Revenues EBIT Interest Expense Taxable Income Tax liability (40%) Earnings after taxes $2,000 310 60 250 100 150 338 Note: GUM0%current cost of debt is 10 percent while its cost of equity is 15 percent if the forecasted funds for expansion are raised via debt, the cost of debt would increase to 15 percent and the cost of equity will jump to 17.5 percent. Conversely, if the additional funds are raised by floating equity (stocks), the cost of debt will be 9 percent while that of equity will be 12 percent. New stocks can be floated to net $10 per sharc. Required Given the above information, recommend whether GUMO should use debl or equity financing for the expansion. Provide quantitative support for your recommendation.

Explanation / Answer

(Figures are in thousand dollars for calculation)

To get on our decision on whether to use Debt or Equity for financing we can use WACC (weighted average cost of capital).

Current WACC = (Debt/(Debt +Equity))*Cost of debt(1-tax rate) + (Equity/(Debt +Equity))*cost of equity

Note: Debt considered here is only Long term debt, capital generally refers to fund that is used by firm to fund its long term requirements.

Current WACC = (300/(300+400))*0.10*(1-0.4) + (400/(300+400))*0.15 = 0.02571 +0.08571 = 0.1114

So current WACC is 11.14%

Scenario 1 – If funds are raised via Debt : Increase in Debt will be 100000

WACC = (100300/(100300+400))*0.15*(1-0.4) + (400/(100300+400))*0.175 = 0.0896+0.000695 = 0.09029 = 9.02%

Scenario 2 – If funds are raised via Equity : Increase in Equity will be 100000

WACC = (300/(300+100400))*0.09*(1-0.4) + (100400/(300+100400))*0.12 = 0.0001608+0.1196 = 0.1198 = 11.98%

So as per WACC, raising funds via Debt will be cost effective.

Note: The amount of EFN does not looks correct to me as its mentioned as 100m while the current balance sheet size is only 1m, that means GUMO is planning to expand 100 times, also looking at income statement, pro forma revenue is only 2.2m which means there is not much estimate of increase in revenue as of capital i.e. 100m. I have calculated the WACC assuming EFN is correct here.

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