Question: Colton Conveyance, Inc. 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?