ABC Corporation is considering building an overseas manufacturing facility to produce radar detection systems. As a consultant to ABC, you have the contract to determine the appropriate discount rate for evaluating this project.
Current information regarding ABC includes:
Debt: 25,000 bonds outstanding, each with a coupon rate of 6.5% paid semi-annually, par value of $1,000, maturity of 20 years, and current value of 96% of par.
Common Stock: 400,000 shares outstanding with a current value of $89/share. An annual dividend of $4.74 has just been paid, and dividends are expected to grow by 9% annually into the foreseeable future.
Preferred Stock: 35,000 shares of 6.5% stock with a par value of $100/share, and a current value of $99/share.
Tax rate: ABC’s combined tax rate is 34%.
Other liabilities: ABC has the usual accounts payable and accruals on its balance sheet, but does not regularly utilize any interest-bearing debt other than the bonds described above.
Risk Adjustment: Since the new manufacturing facility is to be built overseas, management is suggesting an adjustment factor of +2% to account for the increased riskiness.
Showing your work, recommend an appropriate discount rate for ABC’s proposed venture. You must show your work to receive any credit.
