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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.

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M939544

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