Reference no: EM132619872

You, CPA, work as an analyst for Glo Inc., a publicly traded and rapidly growing cosmetic company. Glo's products retail at a popular beauty store chain across Canada. Recently, Glo has been experiencing stockouts due to overwhelming demand resulting from a social media influencer who recently commented on her love of Glo's products.

Part of Glo's strategic plan is to capture market segments that are traditionally underserved. Glo's management believes that the market for men's care products is underserved and would be an excellent fit. Glo has already reached out to the male partner of the social media influencer, and he has agreed to be part of the branding campaign for men's products. However, this will require a significant marketing investment up front - $250,000 before the first product is even introduced to the market and $45,000 per year after that.

Earlier this year, Glo conducted a series of focus groups. In the focus groups, the research team noticed that men like how beauty products make them feel but do not want to be seen buying them. Men also prefer to buy all their beauty products in one location, whereas women don't mind shopping in two or three stores. Finally, the men in the focus groups indicated that they want immediate results from a skin-care line, whereas women consider the care to be more of a long-term investment since products often take time to be effective.

Glo's marginal tax rate is 20%.

The CEO has asked you to provide input on the following issues.

Glo has already been running at maximum capacity for several months, and is looking to expand its production facility at a cost of $4 million in order to introduce the new product line, as well as to increase production of existing offerings.

Glo currently has an unsecured bank loan of $2.5 million and a before-tax interest rate of 9%. There are $6 million in common shares outstanding with an 18% cost of equity. The market value for debt and equity components is equal to the above values.

Glo has determined two viable options for raising the $4 million in capital necessary to fund the new production facility:

bank loan (7% before-tax)

preferred shares (12%)

The bank loan would require Glo to use the building as security and maintain a minimum working capital ratio.

Question 1: Calculate Glo's weighted average cost of capital under each funding alternative based on the information provided above.

Question 2: Identify the funding alternative with the lowest cost of capital and discuss any qualitative considerations related to each option.