Question

Qinetiq plc. makes full body scanners for airport security systems. The Transportation Security Administration​ (TSA) is considering ordering 100 such machines at a total cost of​ $20 million. To ramp up production for the order Qinetiq is considering building a new factory. To evaluate the new factory​ project, Qinetiq needs to estimate its cost of capital. Review the following information and answer the questions that follow to help Qinetiq with its analysis.

Debt Equity

Number of bonds outstanding​ = 150,00 Market price​ = $37

Face value​ = ​$1,000 Shares outstanding​ = 5 million

Maturity​ = 4 years Beta​ = 1.46

Coupons​ = 7​% paid annually ​Risk-free rate​ = 6​%

Market price​ = ​$1,027.47 Expected return on market​ = 12​%

Tax rate​ = 30​% ​

a.  What is the​ after-tax cost of debt for Qinetiq​ bonds?

b. According to the​ CAPM, what is the required return of Qinetiq​ shareholders?

c.  What is the weighted average cost of capital​ (WACC) for​ Qinetiq?

Answer 1

Part (a):

Cost of debt= YTM calculated at 6.203541% using RATE function of Excel as follows:

Given, Tax rate= 30%

Therefore, after-tax cost of debt (Rd)= 6.203541*(1-30%) = 4.342479%

Part (b):

Required rate of return on equity (Re) = 14.76% as follows:

Part (C):

Note: Number of bonds outstanding is given in the problem as 150,00. It is assumed that the correct number is 150,000.

Weighted Average Cost of Capital (WACC)= 10.03% as follows: