Donner Inc will finance a proposed investment by issuing new securities while ma

Question

Donner Inc will finance a proposed investment by issuing new securities while maintaining its optimal capital structure of 60% debt and 40% equity.  The firm can issue bonds at a price of $950.00 before the $15 flotation costs.  The 10-year bonds will have an annual coupon rate of 8% and a face value of $1000.  The company can issue new equity at a before -tax cost of 16% and its marginal tax rate is 34%. What is the appropriate cost of capital to use in analyzing this project.

A. 3.63%

B. 11.81%

C. 8.77%

D. 9.97%

Explanation / Answer

D)

Putting the stats into a BAII financial calculator we get a before tax bond cost (yield to maturity) of 9.0134

So the after tax cost is 9.0134*(1-.34)= 5.9488 * .6 (weighting)= 3.5693

The equity will be 16*.4 (weighting) or 6.4

Add the two together and you get 9.97%

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