AOT Inc., which operates in the business of creating Titan figures, is considering a new upcoming project, codenamed “Colossal”. Eren Yeager, the owner of the company, has provided the following financing information for the project to you:

AOT Inc. plans to issue new debt for this project in the form of a single bond issuance, comprising 700 bonds, each with a face value of $1,000 and a coupon rate of 10%. The maturity of this bond issuance is eight years and coupons are paid semi-annually. The current market price of each bond is $862. This bond issuance has a default probability of 1.7% with an expected loss rate of 48% in the event of default.

AOT Inc. also plans to issue 50,000 new common shares to finance the project, with each share trading at the price of $5.00. The market portfolio has a risk premium of 6% and a volatility of 8%. The covariance between the market portfolio and the stocks of AOT is 0.00832 and the risk-free rate is 2.2%. Finally, the corporate tax rate of AOT Inc. is 30%.

 Calculate the cost of capital for Project “Colossal”.

 Eren Yeager lets you know that the default probability and loss rate estimates are not accurate and instead, the company’s financial advisor recommends using a debt beta of 1.65 for the bonds of the firm. Using this information, calculate the cost of debt and the cost of capital for Project “Colossal”.

Answer rating: 100% (QA)

Calculating the Cost of Capital for Project Colossal Part 1 Using provided default probability and loss rate 1 Cost of Debt Bond price P 862 Face valu... View the full answer