The capital structure of Global Airlines is 70% common stock; 20% preferred stock and; and 10% long-term (10 year) debt. The risk premium of Global’s stock = 13%; the risk free rate = 2.5%.
Global Airline’s credit rating is A-; spread of 10-year A- rated corporate debt = 3.5%; yield to maturity of US 10-year Treasury bonds = 5.5%. Global Airline’s effective tax rate is 25%.
The company recently issued preferred stock with a par value = $60/ share and pays a 9% dividend yield. Issuance cost were 5% of par.
a. What is Global Airlines’ cost of equity?
b. What is Global Airlines’ after-tax cost of debt?
c. What is Global Airlines’ cost of preferred stock?
d. The company is considering expanding its operations is Cuba and wants to determine its weighted average cost of capital (WACC). Calculate the company’s WACC based on the above information.
e. Global Airlines’ analysts estimate the internal rate of return (IRR) of the expansion into Cuba is 15%. If they finance the expansion using ONLY equity should Management proceed with the project? Why or why not?
f. If the firm finances the expansion using all three sources of financing in the proportions stated above (e.g. its WACC), should it proceed with the project? Why or why not?