Solved: Colton Conveyance Inc is a large U S natural gas

pipeline

Colton Conveyance, Inc., is a large U.S. natural gas pipeline company that wants to raise $120
million to finance expansion. Colton wants a capital structure that is 50% debt and 50% equity.
Its corporate combined federal and state income tax rate is 40%. Colton 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 half by equity and half by debt.
A London bank advises Colton 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
Colton first borrowed $20 million in the European market at 6% and matched this with an
additional $20 million of equity, additional debt beyond this amount would cost 12% 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 Colton raises $20 million in the equity market and an additional $20 in the debt market at
the same time.
b. If Colton 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?

Colton Conveyance Inc is a large U S natural gas pipeline

ANSWER
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