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Easy2 marksMultiple Choice
Estimating the Cost of CapitalCost of capitalCost of debtSection B
This question is part of a case study — click to read the full scenario(Case 21)

Section B - Case 2: AeroDynamics PLC

Scenario: AeroDynamics PLC, an aerospace manufacturer, is evaluating the acquisition of a target company, HeliParts. HeliParts has just paid an annual dividend of $0.40 per share. Historical dividend data shows that 4 years ago, the dividend was $0.32 per share. HeliParts' cost of equity is estimated at 12%. The company has 5 million ordinary shares in issue. HeliParts also has $10 million of 8% irredeemable bonds trading at $105 per $100 nominal value. The corporate tax rate is 25%.

Calculate the historical annual dividend growth rate for HeliParts. (Express your answer as a percentage to two decimal places, e.g., 5.25).

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ACCA · Question 23 · Estimating the Cost of Capital

Section B - Case 2: AeroDynamics PLC

Scenario: AeroDynamics PLC, an aerospace manufacturer, is evaluating the acquisition of a target company, HeliParts. HeliParts has just paid an annual dividend of $0.40 per share. Historical dividend data shows that 4 years ago, the dividend was $0.32 per share. HeliParts' cost of equity is estimated at 12%. The company has 5 million ordinary shares in issue. HeliParts also has $10 million of 8% irredeemable bonds trading at $105 per $100 nominal value. The corporate tax rate is 25%.

What is the after-tax cost of debt for HeliParts' irredeemable bonds?

Answer options:

A.

8.00%

B.

7.62%

C.

6.00%

D.

5.71%

How to approach this question

Use the formula for the cost of irredeemable debt: Kd = [i * (1 - T)] / P0. Where i is the coupon interest, T is the tax rate, and P0 is the market price.

Full Answer

D.5.71%✓ Correct
For irredeemable debt, the after-tax cost of debt ($K_d$) is calculated as: $K_d = \frac{i(1 - T)}{P_0}$ $i = 8$ (8% of $100 nominal) $T = 0.25$ $P_0 = 105$ $K_d = \frac{8(1 - 0.25)}{105} = \frac{6}{105} = 0.05714$ Expressed as a percentage: 5.71%.

Common mistakes

Dividing by 100 (nominal value) instead of 105 (market value).
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