Holdings accept the telecommunications project

(i) calculate the amount of interest that will be paid in the first month of the 25th year into the loan.

(ii) calculate the total amount of interest that will be paid over the life of the loan.

(a) (i) Calculate and justify a suitable weighted average cost of capital based on T. Holdings’ existing capital structure.

(ii) Justify and calculate a suitable discount rate for the telecommunications project.

Debt-free, Inc., an unlevered firm, is planning to use debt in its capital structure. The firm currently has 5,000 shares outstanding trading at $60 per share. The firm plans to sell 150 6% annual-coupon, 10-year bonds at their face values of $1,000 each and use the proceeds to repurchase some of its shares. When the bonds mature, Debt-free, Inc. plans to reissue new bonds to pay off the principal and to “roll over” its debt this way indefinitely. Assume the firm’s cost of debt does not change and there are no costs of financial distress. Earnings before interest and tax are expected to remain at $28,000 per year forever and the firm has a

dividend policy of paying out all of its earnings. Maureen currently owns 100 shares of Debtfree, Inc.

Answer:

ANSWER 1

The interest component of EMI over the life of the loan has been computed at $509378.61.

(For Computation refer Above)

• There has been no intention to set off the loan earlier;

• There has been no change in rate of interest;

On perusal of the computation in Excel, it shall be seen that the present value of loan when discounted @1.2% is greater than the initial amount of principal lent under the agreement. Further, the method is based on time value of money and the difference arise on account of different in rate of interest used. In addition, the rate of discount used for the purpose of computation of present value is risk free interest rate as interest on savings is nearly equivalent to risk free interest. Also, the discounted EMI includes both interest and principal.

The difference between the principal actually granted initially and the computed value of present loan by discounting @1.2% $ 2,99,143.9229. The same implies that I am paying extra amount to lender on account of risk that has been borne by him by giving me loan. The amount that has been awarded to lender on account of extra risk borne by him stands at $ 2,99,143.9229

It shall be pertinent to note that for deriving the cost of equity of the tested company only Bad Inc.  Beta has been taken as the company activities are similar to the tested company. Accordingly, the cost of equity stands at 13.47%.

The details of the cash flow for first five years of the project has been provided here-in-under:

Part B(ii)

• Changes in Working Capital is realised at end

Part B(iv)

PART A (iii)

PART A (iv)

PART B (iv)

PART B (v)

Study.com. (2018). The Modigliani-Miller Theorem: Definition, Formula & Examples. Retrieved October 3, 2018, from Study.com: https://study.com/academy/lesson/the-modigliani-miller-theorem-definition-formula-examples.html