ABC firm will finance a proposed investment by issuing new securities while main

Question

ABC firm 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 price of $950.00 before $15 flotation costs.

The 10-year bonds will have an annual coupon rate of 8% and face value of $1,000. The company can issue new equity at a before- tax cost of 16% and its marginal tax rate at 34%.

What is the appropriate cost of capital use in analyzing this project?
A. 9.97%
B. 3.36%
C. 11.81%
D. 8.77%

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Explanation / Answer

calculation of cost of debt Coupon payment =8%*1000=$80 $950.00 - $15 =$80/(1+r) +$80/(1+r)^2 ....$1080/(1+r)^10 r=9.01% re=16% WACC = 16%*.4 +9.01%*60%*(1-34%) =9.97% A. 9.97%

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