Question:
DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following combination of debt and equity to finance the investment:
• Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8%, and flotation costs of 2% of par.
• Use $35 million of funds generated from earnings.
The equity market is expected to earn 12%. US Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is estimated to be .60. DQZ is subject to an effective corporate income tax rate of 40%.
The before-tax cost of DQZ's planned debt financing, net of flotation costs, in the first year is
1. 11.80%
2. 8.08%
3. 10.00%
4. 7.92