Question

6. Suppose you have been hired as a financial consultant by Defence Electronics Ltd (DEL), a large publicly traded firm that is the market-share leader in radar detection systems (RDSs). The company is considering setting up a manufacturing plant overseas to produce a new line of RDSs. This will be a five-year project. The company bought some land three years ago, If the land were sold today, the net proceeds would be $3.9 million after taxes. In five years, the land will be worth $4.7 million after taxes. The company wants to build its new manufacturing plant on this land; the plant will cost $11.6 million to build. The project requires $643 000 in initial net working capital investment at year 0 to get operational.

The following market data on DEL’s securities are current:

• Debt: 35,000 bonds, 6.5% coupon bonds, 25 years to maturity, selling for 97% of par; the bonds have a $1000 par value each and make half-yearly payments.

• Common shares: 641,000 ordinary shares outstanding, common shares have a $1 par value, selling for $79 per share; the beta is 1.23.

• Preference stocks: 37,000 outstanding preference shares, paying $6.3 dividend annually, selling for $96 per share.

• Market: 6.75% expected market risk premium; 3.8% risk-free rate.

• DEL’s tax rate is 30%.

a) Calculate DEL ‘s cost of debt, cost of common equity and cost of preferred stocks.

I cannot understand how to calculate YTM for the cost of debt. Please solve it with all the details.

Answer 1