Gulf Electric Company (GEC)

question 86

Multiple Choice

Gulf Electric Company (GEC)
Gulf Electric Company (GEC) uses only debt and equity in its capital structure. It can borrow unlimited amounts at an interest rate of 10 percent so long as it finances at its target capital structure, which calls for 55 percent debt and 45 percent common equity. Its last dividend was $2.20; its expected constant growth rate is 6 percent; its stock sells on the NYSE at a price of $35; and new stock would net the company $30 per share after flotation costs. GEC's tax rate is 40 percent, and it expects to have $100 million of retained earnings this year. GEC has two projects available: Project A has a cost of $200 million and a rate of return of 13 percent, while Project B has a cost of $125 million and a rate of return of 10 percent. All of the company's potential projects are equally risky.
-Refer to Gulf Electric Company.Assume now that GEC needs to raise $300 million in new capital.What is GEC's marginal cost of capital for evaluating the $300 million in capital projects and any others that might arise during the year?

• A) 6.00%
• B) 13.77%
• C) 12.66%
• D) 9.50%
• E) 9.00%

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Definitions:

Bond Issuance

The process by which a borrower, typically a corporation or government entity, issues bonds to raise funds from investors.

Effective Interest Method

An accounting technique used to allocate the discount or premium on bonds payable or receivable over their life, reflecting the actual interest rate over the period.

Amortization

The process of spreading out a loan or intangible asset cost over its useful life.

Bond Discount

The variance between a bond's official value and the reduced price at which it is actually sold.