A new cross-country, trans-mountain 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 financial...

A new cross-country, trans-mountain 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 financial arrangements

of this adventurous project. The WACC for

similar projects has averaged 10% per year. (a) Two

financing options 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 option requires only 20% equity

funds and the balance obtained by a massive

international loan estimated to carry an interest rate of 12.5% per year, which is, in part, based on the

geographic location of the pipeline. 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 acceptable

loan interest rate for each financing option?