Tutorial 1 Model Answer

Question 1:

B. Before Tax and after tax cost of debt:

c. Tax shield = 12%*1000*40%=$48.

Question 2:

Pre- Tax cost of Debt= (90+(1000-960)/20)/ ((1000+960)/2)= 9.4%

After- Tax cost of Debt= 9.4% *(1-40%)=5.6%

Question 3:

Cost of debt for each alternative using the approximation formula

 For alternative C:

I= 1000*6% = $60

Nd= 1000 – 30 = $970

For alternative D:

I= 1000*5% = $50

Nd= 925 (1000-75) – 30 = $895

Only alternative D is suitable to finance the new project ( Cost 3.83%< Return 3.85%)

Question 4:

Np= $90- $5- $5= $80

D = 8%*90 = 7.2$

r = 7.2/80 = 9%

Question 5:

r = ($5/$70) + 0.03 = 10.14%