Qinetiq plc. makes full body scanners for airport security systems. The Transpor
ID: 2618329 • Letter: Q
Question
Qinetiq plc. makes full body scanners for airport security systems. The Transportation Security Administration (TSA) is considering ordering 100 such machines at a total cost of $20 million. To ramp up production for the order Qinetiq is considering building a new factory. To evaluate the new factory project, Qinetiq needs to estimate its cost of capital. Review the following information and answer the questions that follow to help Qinetiq with its analysis Debt Number of bonds outstanding250,000 Face value Maturity $1,000 6 years 8% paid annually $1,014.72 35% Equity Market price Shares outstanding Beta Risk-free rate- Expected return on market- $34 5 million 1.24 5% 11% pons Market price- Tax rate a. What is the after-tax cost of debt for Qinetiq bonds? »96 (Round to two decimal places.) b. According to the CAPM, what is the required return of Qinetiq shareholders? »96 (Round to two decimal places.) c. What is the weighted average cost of capital (WACC) for Qinetiq? ?96 (Round to two decimal places.)Explanation / Answer
a. The After-tax cost of debt for bonds = 8% (1 - 0.35) = 5.20% b. As per CAPM : Required return = rf + B (Mr - rf) Thus, Required return = 0.06 + 1.24 (0.11 - 0.06) = 0.122 or 12.2% c. WACC = Market value Debt share/Total capital (cost of debt after tax) + Market Eq. share / Total capital (cost of equity) Debt share = (250000*1014.72) / (250000*1014.72 + 5000000*34) =0.60 Equity share = (5000000*34) / (250000*1014.72)+ (5000000*34)=0.40 WACC = 0.60 *0.052+ 0.40*0.122 = 0.08 or 8%