Engineering Economy 7th Edition by Leland Blank ,Anthony Tarquin

Exercise 2

Growth Transgenics Enterprises (GTE) is contem­plating the purchase of its rival. One of GTE's ge­netics engineers got interested in the financing strategy of the buyout. He learned there are two plans being considered. Plan 1 requires 50% eq­uity funds from GTE's retained earnings that cur­rently earn 9% per year, with the balance borrowed externally at 6%, based on the company's excel­lent stock rating. Plan 2 requires only 20% equity funds with the balance borrowed at a higher rate of 8% per year.
a) Which plan has the lower average cost of capital
b) If GTE's owners decide that the current cor­porate WACC of 8.2% will not be exceeded, what is the maximum cost of debt capital al­lowed for each plan Are these rates higher or lower than the current estimates