AirJet Best Parts Inc. is now considering that the appropriate discount rate for
ID: 2677939 • Letter: A
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.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
Explanation / Answer
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.
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. (5 pts)
5.50%
b. What is the after-tax cost of debt if the tax rate is 34%? (5 pts)
5.50% x 34% = 1.87% - 5.50% =3.63%
c. Explain what other methods you could have used to find the cost of debt for AirJet Best Parts Inc.(10 pts
The Yield to maturity (YTM) method could have been used, which would of allowed AirJet Best Parts Inc.
to compute the actual YTM of the new bond issueby incorporating all the cash flow associated with the issue, assuming that thebond will be held until it’s maturity and all scheduled payments relating to thisbond would have been made on time.
AirJet Best Parts Inc. could of usedthis method as an estimation of future return on a bond, and adjusting for thedifference, if any
d. Explain why you should use the YTM and not the coupon rate as the required return for debt. (5 pts)
The coupon rate could cause a serious depreciation of funds if this method is usedbecause; the coupon rate uses the face value of the bond,
in order to compute thebond(s) value, and does not take into consideration the price at which the issue of this bond was or the redemption value of the bond.
YTMmethod ----------use because the Yield to maturity (YTM) method incorporatesall fluctuations and the issuing expenses, if any. Thus, the Yield to maturity(YTM) method is a better method to use, and not the coupon rate as the required return for debt
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