### Question details

The firm decides to raise \$30 million by selling equity and debt. The investment (Step 4 & 5)
\$ 12.00

Step 4

The firm decides to raise \$30 million by selling equity and debt. The investment bankers hired by your firm contact potential investors and come back with the following numbers:

• Debt that pays \$1 million coupons a year and \$18 million maturity value after 10 years will sell for \$20 million.
• Equity that pays expected dividends of \$1.2 million starting next year and growing at a rate of 3 percent per year thereafter sells for \$10 million.

Question 12: Calculate the cost of debt, equity, and the WACC.

Before starting your calculations, review the following materials:

• cost of capital and choice of financing
• equity, debt, and preferred stock

Submit your Cost of Debt Report and Calculations to the dropbox below. Be sure to show your calculations in Excel and provide a narrative analysis in PowerPoint. Your narrative analysis should summarize the results of your analysis and make recommendations for the benefit of company.

Step 5

Your firm has decided to spin off Android01 and Processor01 as a separate firm. The owners of the new firm will be equity holders and debt holders. After speaking with potential investors, investment banks have identified two possible capital structures (structure of equity and debt ownership):

• Debt holders receive debt that pays them coupons of \$2 million a year, and \$30 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 4 percent. Equity holders receive expected dividends of \$3 million starting from year 5, and growing at a rate of 4 percent per year (a growing perpetuity). They price the equity using a discount rate of 7.5 percent.
• Debt holders receive debt that pays them coupons of \$1 million a year, and \$12 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 3.5 percent. Equity holders receive expected dividends of \$3.9 million starting from year 5, and growing at a rate of 4.5 percent per year (a growing perpetuity). They price the equity using a discount rate of 7 percent.

Your firm receives all the proceeds from the sale debt and equity.

Prepare a Capital Budgeting and Cost of Capital report that answers the following Question 13.

Question 13: Which particular capital structure should be chosen for the spin-off?

Before starting your calculations, review the following materials:

• cost of capital and choice of financing
• equity, debt, and preferred stock

Submit your Capital Budgeting and Cost of Capital Report to the dropbox below

### Solutions

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