Question

Please solve the following problem WITHOUT USING EXCEL. Please type your answer.

Roberto Inc. is a manufacturing company. The company has always followed their ideal capital structure which the management insists is 40% debt and 60% equity capital. The company can issue bonds for 9% coupon rate with 22 years to maturity. The interest is paid semi-annually. The bonds can be issued with a price of $835.42 today. Roberto's marginal tax rate is 40%. For cost of equity, the company uses the CAPM based on SML. The risk-free rate in the market is 8% and the market rate of return is 14%. The company has a beta of 1.1. Roberto is experiencing a highly abnormal growth rate of 30%. This growth rate is expected to continue for four years. After year four, the growth rate is expected to return to a normal 8% and remain constant afterwards for the foreseeable future. Roberto just paid a dividend of $1.15. Furthermore, Roberto is evaluating several projects to invest in. The top project that is being considered will cost $1,000,000 and promises to pay $500,000 in year one, $400,000 in year two, $300,000 in year three and $100,000 in year four. This project will cease to exist with no salvage value at end of year four. So, the cash flow would look like the following: Year CF ($ in 000's) -1,000 (Initial Outlay) on m 500 400 300 100 Based on the information provided above, answer the following questions: 1. What is Roberto's cost of debt before taxes? a. 11% b. 12% C. 10% d. 8%

Answer 1

Using financial calculator
N=22*2=44
PMT=9%*1000/2=45
FV=1000
PV=-835.42
CPT I/Y=5.5000%

Pre-tax cost of debt=yield to maturity=5.5%*2=11%