Busn Essay

1786 Words Jul 20th, 2012 8 Pages
Course Project Part II

You will assume that you still work as a financial analyst for AirJet Best Parts, Inc. The company is considering a capital investment in a new machine and you are in charge of making a recommendation on the purchase based on (1) a given rate of return of 15% (Task 4) and (2) the firm’s cost of capital (Task 5).
Task 4. Capital Budgeting for a New Machine
A few months have now passed and AirJet Best Parts, Inc. is considering the purchase on a new machine that will increase the production of a special component significantly. The anticipated cash flows for the project are as follows:
Year 1 $1,100,000
Year 2 $1,450,000
Year 3 $1,300,000
Year 4 $950,000
You have now been tasked with
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is considering issuing new bonds. Select current bonds from one of the main competitors as a benchmark. Key competitors include Raytheon, Boeing, Lockheed Martin, and the Northrop Grumman Corporation.

a. What is the YTM of the competitor’s bond? You may use a number of sources, but we recommend Morningstar. Find the YTM of one 15 or 20 year bond with the highest possible creditworthiness. You may assume that new bonds issued by AirJet Best Parts, Inc. are of similar risk and will require the same return. (5 pts) Answer: Lockheed Martin=4.40%

b. What is the after-tax cost of debt if the tax rate is 34%? (5 pts) Answer: 4.40 %*(1-0.34)=2.90%

c. Explain what other methods you could have used to find the cost of debt for AirJet Best Parts Inc.(10 pts)
Answer: There are two methods that can be used to compute the cost of debt. The other is to use estimates of current rates based on the bond rating expected on new debt. And the easier choice, of course, is by using the YTM on existing debt.

d. Explain why you should use the YTM and not the coupon rate as the required return for debt. (5 pts)
Answer: YTM should be used because it is the rate of return anticipated on a bond if it is held to maturity. The calculation of YTM takes into account the purchase price, redemption value, time to maturity, coupon yield, and time between
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