Reference no: EM132712999
The following information is available to assist you in your task:
1. Selected information from ABCD's financial statements is as follows:
Long-term debt $15,000,000
Preferred shares $7,500,000
Common shares $10,000,000
Retained earnings $20,000,000
2. The preferred shares were issued at their par value of $75 and pay an annual dividend of 8%. The shares are trading for $70.
3. ABCD's common shares were issued at $20 and are trading for $90. The firm recently paid a dividend of $9 per share. Dividends are projected to grow annually at 5% for the foreseeable future.
4. ABCD's long-term debt is in the form of bonds that have 10 years to maturity and pay 12%, semi-annually. ABCD has been advised by RBC Dominion Securities (its underwriter) that it can issue similar new long-term debt at an effective yield of 14%.
5. Flotation costs will be 2% on debt, 4% on preferred shares and 5% after-tax on common shares.
6. The return on the market portfolio is 14%, the market risk premium is 8%, and the firm's beta is 1.5.
7. ABCD's tax rate is 40%.
Required
Problem (a) Calculate ABCD's required rate of return on this similar-risk project.
Problem (b) Assuming that the long-term debt described above was trading for 102.5, what would the effective yield be on these bonds?