Gazelle Manufacturing is a major producer of farm equipment. Currently, the firm has two divisions: a machinery division and a farm implement division - each have different degrees of risk. You have obtained the following partial information for Gazelle Manufacturing:
Debt
Bond A 10 year bond 9% paid semi-annually issued 2008 $1,000,000
Bond B 15 year bond 6% paid semi-annually issued 2010 $4,000,000
Bond C 3 year bond 5% paid semi-annually issued 2012 $1,000,000
Total bonds issued and outstanding $6,000,000
Common Equity
Common Shares $200,000
Contributed Surplus $1,800,000
Retained Earnings $2,000,000
Total Equity $4,000,000
You observe that 30 day Government T-bills are selling to yield 0.2432445% or 3% per year and the market risk premium for the firm is 10%. The average beta for the firm is 1.4. The firm has a marginal tax rate of 40%. The company shares are currently selling in the market for $56.55 and the firm just paid its most recent dividend of $8.00. Management expects to be able to sustain a growth rate of 2.5% forever.
a. Based on the above information, find out the cost of borrowing using debt for the current company.