Task 5: Cost of Capital Aero Plain, Inc. is now considering that the appropriate
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Task 5: Cost of Capital
Aero Plain, Inc. is now considering that the appropriate discount rate for the new machine should be the cost of capital and would like to determine it. You will assist in the process of obtaining this rate.
1. Compute the cost of debt. Assume Aero Plain, Inc. is considering issuing new bonds. Select current bonds from one of its main competitors, Raytheon, Boeing, Lockheed Martin, and the Northrop Grumman Corporation as the benchmark return for the new bonds.
You may use a number of sources to get bond information about a comparable firm to use as a benchmark. We recommend Morningstar. But Morningstar is a little difficult to navigate so you will find it much easier to search directly from your search engine (Google or Yahoo) for the desired firm
Aero Plain, Inc. is now considering that the appropriate discount rate for the new machine should be the cost of capital and would like to determine it. You will assist in the process of obtaining this rate. Compute the cost of debt. Assume Aero Plain, Inc. is considering issuing new bonds. Select current bonds from one of its main competitors, Raytheon, Boeing, Lockheed Martin, and the Northrop Grumman Corporation as the benchmark return for the new bonds. You may use a number of sources to get bond information about a comparable firm to use as a benchmark. We recommend Morningstar. But Morningstar is a little difficult to navigate so you will find it much easier to search directly from your search engine (Google or Yahoo) for the desired firm's bonds and selecting Morningstar from the list of web pages. Here is a sample of the correct page for an unrelated company, Briggs & Stratton (BBG), manufacturer of Simplicity garden tractors. Briggs has only issued one bond which matures in 2020. The aerospace firm you select will have many. Select the one with the longest maturity date. You may assume that new bonds issued by Aero Plain, Inc. are of similar risk and will require the same return. In the Briggs & Stratton example, the price is shown at 110.9. What does that mean? What is the market price of one BGG bond expressed as a dollar amount? What is the YTM of the competitor's bond you have selected? Include a screen shot of the page showing the YTM. What is the after-tax cost of debt if the tax rate is 34%? Show your calculations. Explain why you should use the YTM and not the coupon rate as the required return for debt. The cost of common equity may be derived using the CAPM model. For beta, use the average beta of three competitor competitors. You may obtain the betas from LexisNexis (in the course Home tab, select "Student Resources," then select "Library," "Databases," then "LexisNexis.") You can also get the information you need from Google Finance or Yahoo Finance Assume the risk free rate to be 3% and the average market return to be 7%. Using the CAPM model, what is the cost of common equity? Show your calculations and include a screen shot of the page from which you observed the required data. Explain the advantages and disadvantages to use the CAPM model as the method to compute the cost of common equity. Compare and contrast this method with the dividend growth model approach. One method to calculate the required rate of return on preferred stock is to use the Gordon Model, also called the Dividend Growth Model. But with preferred stock, dividends are always the same and never change. The growth factor is, therefore, zero. Using the dividend growth model with zero growth, assuming the dividend paid for preferred stock is $2.75 and the current value of the stock is $50 per share; compute the cost of preferred equity. Show your calculations. What other means could we use to compute the cost of preferred equity? Explain. Assuming that the market value weights of these capital sources are 30% bonds, 60% common equity and 10% preferred equity, what is the weighted cost of capital of the firm? Should the firm use this WACC for all projects? Explain and provide examples as appropriate Re-compute the net present value of the project based on the cost of capital you found. Do you still believe that your earlier recommendation for accepting or rejecting the project was adequate? Why or why not? Show your calculations.Explanation / Answer
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