Question

ABC Mining is reviewing the purchase of a new machine. Their capital structure consists of: $5 million in loans at a stated rate of 5%, $5 million in bonds that sold at par for $1000 (flotation costs were $26 per bond, coupon rate 4.5%, 10 years to maturity) $10 million in common stock with the most recent dividend of $1.20, growth rate of 5%, current stock price of $35. 40% tax rate.

1. What is their cost of loan debt?

a. 5% b. 3% c. 2% d. 10%

2. What is their cost of bond debt?

a. 2.9% b. 4.83% c. 4.5% d. 10%

3. What is the cost of capital for equity?

a. 8.4% b. 10% c. 8.6% d. 5.2%

Answer #1

Solution:

1. Cost of loan debt = rate of interest (1- tax rate)

Cost of loan debt = 5%*(1-0.40)= 3%

Option B is correct

2. Cost of bond debt = ?..

Par value ( FV) = $1000

PV= 1000-26= $974

Coupon rate= 4.5%

Interest (PMT) = $1000*4.5%=$45

Years to maturity (nper) = 10 years

Rate =?

Rate(nper,PMT,PV ,FV)

Rate (10,45,-974,1000)= 4.83%

Option B is correct

3. Dividend paid ( D0)= 1.20

Growth ( g)= 5%

Price (P0)= $35

D1= 1.20*(1.05)= $1.26

Cost of equity = D1/P0 + g

Cost of equity= 1.26/35 + 0.05= 8.6%

Option C is correct

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