Nova Inc. is evaluating a project with a total initial cost of $8,000,000. The project will not change the average risk of the firm. Nova Inc. has a tax rate of 40%. You, as the financial manager, have gathered the following data:
The Project:
Annual cash flow income of $1,150,000 with a 10-year lifespan and no salvage value.
Market:
Average annual return on the TSX: 12%
T-bills annualized return: 4%
Nova has a Beta of 1.1875
Debt:
The firm has $1,000 par value, 6% coupon rate, 15-year bonds outstanding on which semi-annual interest payments are made.
The bonds are quoted at 101.5. New bonds could be issued at par; however, the firm expects flotation costs of 3.5%.
Preferred Shares:
The firm has $50 par value preferred shares with an 8% annual dividend issued and outstanding in the market and the shares are traded at $45.00.
The cost of issuing and selling the new preferred shares is expected to be $7.50 per share, and the new preferred shares are expected to be issued at a par value of $75 per share.
Common Shares:
The firm’s common shares currently have a market price of $80 per share.
The most recent dividend paid by the common shares was $5.66 per share.
The firm’s dividends have been growing at an annual rate of 6%, and this rate is expected to continue in the future.
Issuing costs for new equity are expected to be 7%.
The firm has the following target capital structure:
Debt: 60%
Preferred Equity: 10%
Common Equity: 30%
Calculate the cost of debt using YTM approximation.