Question 21 1 pts Jake the Dog Inc. is investing in a new portable iguana killin

Question

Question 21 1 pts Jake the Dog Inc. is investing in a new portable iguana killing machine that will cost $200,000. The machine has a useful life of 6 years and falls into the 5-year property class for the depreciation purposes. The IRS MACRS schedule for the six years is: (1) 20%, (2) 32%, (3) 19.2%, (4) 11.52%, (5) 11.52%, (6) 5.76%. It will generate $50,000 per year of savings for Jake and can be sold for $50.000 at the end of the 6-year period. Jake's corporate tax rate is 34%. In addition, Jake has 2000 outstanding 9% annual coupon bonds with a $1000 par value, 20 years to maturity and a price of $1085. Jake also has 60,000 shares of common stock outstanding that is selling for $45 per share. This stock has a beta of 2.45 (its Jake he is a risky dog-dude!!), the expected market return is 12% and the risk- free rate is 5%. Finally, Jake has 36,000 shares preferred stock outstanding that pays a 5.5% dividend and sells for $40 per share. What is the after-tax cost of debt for Jake? ? 6.36% ? 4.86% ? 5.44% ? 7.65% 5.36%

Explanation / Answer

Face value = 1,000

Coupon payment = 0.09 * 1000 = 90

Years to maturity = 20

Price = 1085

Before tax cost of debt using a financial calculator = 8.126%

Keys to use in a financial calculator: PV = -1085, FV = 1000, N = 20, PMT = 90, CPT I/Y

After tax cost of debt = 0.08126 ( 1 - 0.34)

After tax cost of debt = 0.05363 or 5.36%

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