AirJet Best Parts Inc. is now considering that the appropriate discount rate for

Question

AirJet Best Parts 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 AirJet Best Parts Inc. is considering issuing new bonds. Select current bonds from one of the main competitors as a benchmark. Key competitors include Raytheon, Boeing, Lockheed Martin, and the Northrop Grumman Corporation.

a. What is the YTM of the competitor’s bond? You may use a number of sources, but we recommend Morningstar. Find the YTM of one 15 or 20 year bond with the highest possible creditworthiness. You may assume that new bonds issued by AirJet Best Parts, Inc. are of similar risk and will require the same return.

b. What is the after-tax cost of debt if the tax rate is 34%?

c. Explain what other methods you could have used to find the cost of debt for AirJet Best Parts Inc.

d. Explain why you should use the YTM and not the coupon rate as the required return for debt.

Explanation / Answer

-3000000 1100000 1450000 1300000 950000 using this we get,NPV =15% Net Cash Flows CF0 = -3000000 CF1 = 1100000 CF2 = 1450000 CF3 = 1300000 CF4 = 950000 Discounted Net Cash Flows DCF1 = 1100000/(1+0.15)^1 = 1100000/1.15 = 956521.74 DCF2 = 1450000/(1+0.15)^2 = 1450000/1.3225 = 1096408.32 DCF3 = 1300000/(1+0.15)^3 = 1300000/1.52087 = 854771.1 DCF4 = 950000/(1+0.15)^4 = 950000/1.74901 = 543165.58 NPV Calculation NPV = 956521.74 + 1096408.32 + 854771.1 + 543165.58 -3000000 NPV = 3450866.74 -3000000 NPV = $450,866.74 we get the following IRR Discounted Net Cash Flows at 19% DCF1 = 1100000/(1+19%)^1 = 1100000/1.19 = 924369.75 DCF2 = 1450000/(1+19%)^2 = 1450000/1.4161 = 1023938.99 DCF3 = 1300000/(1+19%)^3 = 1300000/1.68516 = 771440.56 DCF4 = 950000/(1+19%)^4 = 950000/2.00534 = 473735.31 NPV Calculation at 19% NPV = 924369.75 + 1023938.99 + 771440.56 + 473735.31 -3000000 NPV = 3193484.61 -3000000 NPV at 19% = 193484.61 Discounted Net Cash Flows at 24% DCF1 = 1100000/(1+24%)^1 = 1100000/1.24 = 887096.77 DCF2 = 1450000/(1+24%)^2 = 1450000/1.5376 = 943028.1 DCF3 = 1300000/(1+24%)^3 = 1300000/1.90662 = 681833.44 DCF4 = 950000/(1+24%)^4 = 950000/2.36421 = 401824.92 NPV Calculation at 24% NPV = 887096.77 + 943028.1 + 681833.44 + 401824.92 -3000000 NPV = 2913783.23 -3000000 NPV at 24% = -86216.77 IRR with Linear Interpolation iL = 19% iU = 24% npvL = 193484.61 npvU = -86216.77 irr = iL + [(iU-iL)(npvL)] / [npvL-npvU] irr = 0.19 + [(0.24-0.19)(193484.61)] / [193484.61--86216.77] irr = 0.19 + [(0.05)(193484.61)] / [279701.38] irr = 0.19 + 9674.2305 / 279701.38 irr = 0.19 + 0.0346 irr = 0.2246 irr = 22.46% The company should accept this project since its IRR is higher than the required rate of return and it has a positive NPV

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