Reference no: EM132719686
Sluggo, Inc.Makers of the World's Best 9-inch NailsFinancials (in thousands):
ASSETS: Cash $500; Inventory $100; Accounts Receivables $200; Plant & Equipment $2000, Depreciation $200; Land $2000, Goodwill $100, Trademark $100
LIABILITIES: Current Liabilities $50; Long-Term Liabilities $1650
Gross income for 2020 is $1500 (all credit sales); COGS is $400, Administrative and General expenses are $400, Sluggo pays 4% interest on its liabilities and it's corporate tax rate is 20%.
Capital Improvement:
Sluggo wants to build a factory which would produce the steel for the 9-inch nails. The initial cash outlay is $1000, the factory is expected to be productive for 5 years, the required rate of return is 5%, and the free cash flow each year is expected to be $250.
Capital Structure:
Currently, when Sluggo finances a capital improvement, it uses bonds (debt) and raises 35% of raised money in debt; common stock where 60% of raised money is from retained earnings, and 5% of raised capital is from preferred stock. Capital structure: 35% bonds, 60% common stock, 5% preferred stock.
Bonds: 10-year, 4% coupon, market value is $975, corporate tax rate is 20%
Common stock: Beta of 1.25, risk free rate of 2%, market risk of 9%
Preferred stock: Par value of $100.00, dividend rate is 10%, market value of $100.00
Because Sluggo wants to be efficient when ordering the steel to make the 9-inch nails, it needs to calculate the efficient order quantity (EOQ) and the total inventory cost (TIC). It sells 50,000 9-inch nails each year, the carrying costs are 30% of the product price of $5, and the supplier always charges a $250 delivery charge for each shipment of steel.
When borrowing short-term cash (a 270-day, 9-month loan), Sluggo uses commercial paper, that is an unsecured 9-month loan from a large corporation. If Sluggo's cash conversion cycle is less than 60 days, the APR is 4%. Sluggo may consider raising short term cash by selling a 10-year, 4% coupon bond. However, it realizes lenders will require 6%.
question :
1) Using the WACC:
a. Calculate the after-tax interest required from bonds
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