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What is the market interest rate on Bloddrop’s debt, and what is the component cost of this debt for CCC calculation purposes?

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Solve two questions

First question have 5 parts and second question have 3 parts

FIRST: During the last few years, Blooddrop Laboratories has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are about to make a proposal to implement that expansion. Your first task is to estimate Blooddrop’s cost of capital. The VP Finance, Jeff, has provided data that he believes is relevant to your task.

  • Blooddrop is subject to a 35% income tax rate;
  • The current price of Harry Davis’s 12 percent coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Harry Davis does not use short-term interest-bearing debt on a permanent basis. New bond debt would be privately placed with no floatation costs.
  • The current price of the firm’s 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Blooddrop could issue additional stock but would incur floatation costs equal to 5% of the total proceeds on any new stock issue.
  • Blooddrop’s common stock is currently selling at $50 per share. Its last dividend (D0) was $3.12, and dividends are expected to grow at a constant rate of 5.8 percent in the foreseeable future. Beta on this stock is 1.2. Currently, Treasury bonds are earning a 5.6% return and the current market risk premium is estimated to be 6%. When using a debt cost + risk-premium approach, Blooddrop uses a 3.2% risk premium.
  • Blooddrop aims for a target capital structure of 30% long-term debt, 10% preferred stock, and 60% common equity.

To help you structure the task, Jeff asks you to answer the following questions:

  1. What is the market interest rate on Bloddrop’s debt, and what is the component cost of this debt for CCC calculation purposes?
  2. What is Blooddrop’s cost of preferred stock?
  3. Jeff does not want to issue new shares of common stock. Using CAPM, what is Blooddrop’s estimated cost of equity?
  4. What is the cost of equity based on the debt-cost-plus-risk premium method?
  5. What is Blooddrop’s cost of capital?
  6. SECOND      BrokenLeg Emergency Services Inc.   (“BL”)  is negotiating a   guideline lease for five new ambulances    with   GE Leasing. BL has received its best offer from Diesel Ambulances for a total   price of     $1   million. The terms of the lease offered by International Leasing call for a   payment of $205,000 at    the   beginning of each year of the five-year lease. As an alternative to leasing,   BL can borrow from    a   local union retirement plan and buy the ambulances. The $1 million would be   borrowed on a term   loan   at a 10 percent interest rate for five years. The ambulances fall into the   MACRS five-year class and   have   an expected residual value of $200,000. Maintenance costs would be included   in the lease. If   the   ambulances are owned, a maintenance contract would be purchased at the   beginning of each year   for   $10,000 per year. BL plans to buy a new fleet of ambulances at the end of the   fifth year.    GE   has a 30 percent tax rate while BL has a tax rate of 20 percent.                    a.   What is the present value of the cost of owning the ambulances to BL?      b.   What is the present value of the cost of leasing the ambulances to BL?      c.   What is the net advantage to leasing? Should BL lease or buy the ambulances?  


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