Corporate finance

A new cross-country, trans mountain range water pipeline needs to be built at an estimated first cost of $200,000,000. The consortium of cooperating companies has not fully decided the finance arrangements of this adventurous project. The WACC for similar projects has averaged 10% per year.

(a) Two financing alternatives have been identified. The first requires an investment of 60% equity funds at 12% and a loan for the balance at an interest rate of 9% per year. The second alternative requires only 20% equity funds and the balance obtained by a massive international loan estimated to carry an interest cost of 12.5% per year, which is, in part, based on the geographic location of the pipeline.

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Which financing plan will result in the smaller average cost of capital?

(b) If the consortium CFOs have decided that the WACC must not exceed the 5-year historical average of 10% per year, what is the maximum loan interest acceptable for each financing alternative?

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