Question

You have just been hired as the CFO (chief financial officer) of D.W.O.T.T. Inc. Congratulations!!! I am so super proud of you! Now get to work!

You have lots to do because the last guy was lazy and good for nothing. Don’t worry, you have his face on a dart board in your office. The president of the DWOTT has given you a fairly large ‘to do’ list and wants it ASAP. So you load up on Monster Energy drinks and coffee and settle in to work. It’s ok though, because you LOVE this stuff. Seriously. You do. Now that you are all jacked up on caffeine-let’s get it done!

First on the president’s list is an evaluation of where the firm is at the present. He has provided you with all the information you need to find the answers he wants. For starters, the capital structure for the past year of operations is:

Mortgage bonds                           $2,000
Debentures                                     1,500
Retained earnings                               500

He also wants to know the WACC and has given you the following information about your capital budgeting:

The 20 year $1000 par value mortgage bonds were sold at $952.67 and pay 8%. They had a $47.67 flotation cost.

3. What is the cost of the mortgage bonds?

Timbuktu	Neverland	Middle Earth
Cost	$3,600	$8,750	$6,500
Year 1 CF	$0	$4,000	$2,000
Year 2 CF	0	4,000	2,000
Year 3 CF	0	1,500	2,000
Year 4 CF	0	0	2,000
Year 5 CF	$8,500	3,000	3,000

Answer 1

Cost of bonds can be calculated using I/Y function on a calculator

N = 20, PMT = 8% x 1000 = 80, PV = -(952.67 - 47.67) = -905, FV = 1000

=> Compute I/Y = 9.04% is