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CMA part 2 cost of capital

• 1.  CMA part 2 cost of capital

Posted 6 days ago

where did he get the 1.01 to calculate the market price?

Fact Pattern:  DQZ Telecom is considering a project for the coming year that will cost \$50 million. DQZ plans to use the following combination of debt and equity to finance the investment.  Issue \$15 million of 20-year bonds at a price of \$101, with a coupon rate of 8%, and flotation costs of 2% of par. Use \$35 million of funds generated from earnings. The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is estimated as .60. DQZ is subject to an effective corporate income tax rate of 40%.
Question: 10The before-tax cost of DQZ's planned debt financing, net of flotation costs, in the first year is  A. 10.00% B. 8.08% Answer (B) is correct.The cost of new debt equals the annual interest divided by the net issue proceeds. The annual interest is \$1.2 million (\$15,000,000 × .08 coupon rate). The proceeds amount to \$14,850,000 [(\$15,000,000 × 1.01) market price – (\$15,000,000 × .02) flotation costs]. Thus, the company is paying \$1.2 million annually for the use of \$14,850,000, a cost of 8.08% (\$1,200,000 ÷ \$14,850,000). C. 7.92% D. 11.80%

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Tayba Al-Mehdar
Analyst
Khobar
Saudi Arabia
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• 2.  RE: CMA part 2 cost of capital

Posted 6 days ago
Hi Tabya,