Question

# A bio-technology company is looking to invest \$25 billion in new technology that is expected to...

A bio-technology company is looking to invest \$25 billion in new technology that is expected to produce incremental cash flows of \$7 billion, \$10 billion, and \$12 billion in each of the next three years, respectively. The CFO has asked that you and your team determine whether or not the company should invest in the new technology. In order to finance the project, the company will issue new bonds and new equity.

Of the \$25 billion in costs, \$16 billion will be financed with a new debt issue. In fact, the company is anticipating issuing two different bonds – short-term bonds and long-term bonds. Half of the \$16 billion in debt capital will be raised with the short-term bond issue while the other half will be raised with the long-term bond issue.

Of the \$25 billion in costs, \$9 billion will be financed with new equity. Given this information, your objective is to calculate the weighted average cost of capital that then determine whether the future cash flows (in present value terms) are greater than the \$25 billion investment.

QUESTION: The bio-tech firm will issue two bonds. The first bond is a 5-year, 6% coupon bond with a \$1,000 face value. Similar short-term bonds are priced at \$975. The second bond is a 20-year 7.8% coupon bond (with a \$1,000 face value). The bio-tech firm expects to get \$955 for each of the long-term bonds. Both bonds will pay coupons semiannually. If the marginal tax rate is 40%, what is the after-tax cost of debt? (Hint: you are trying to determine a single cost of debt by combining YTMs for both bond issues – determining how to combine these YTMs is the problem)

6.91%

6.21%

5.10%

8.11%

7.40%

4.46%

5.88%

4.13%

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