oems Rambo Exterminator Company bought a"Bug Eradicator" in April of 2004 that provided a return of 7 percent. It was financed by debt costing 6 percent. In August, Mr. Rambo came up with an " entire bug colony destroying device that had a return of 12 percent. The Chief Financial Officer, Mr. Roach, told him it of 13.5 percent to finance the purchase Is the company following a logica/Cost was impractical because it would require the issuance of common stock at a cost approach to using its cost of capital Solution Rambo Exterminator Company No, each individual project should not be measured against the specific means of financing that project, but rather against the weighted average cost of financing all projects for the firm This principle recognizes that the availability of one source of financing is dependent on other sources. Once a common overall cost is determined, the colony destroying device yielding 12 percent is much more likely to be accepted than the bug eradicator"only yielding 7 percent 11-2 Sullivan Cement Company can issue debt yielding 13 percent. The company paying a 36 percent rate. What is the aftertax cost of debt? Solution: Sullivan Cement Company Kd Yield(1-T =13%(1-.36) 13%(64) =8.32% Copyright C2005 by The McGra-Hill Companies, Inc.Copyright © 2005 by The McGraw-Hill Companies, Inc. S-383 Problems 11-1. Rambo Exterminator Company bought a “Bug Eradicator” in April of 2004 that provided a return of 7 percent. It was financed by debt costing 6 percent. In August, Mr. Rambo came up with an “entire bug colony destroying” device that had a return of 12 percent. The Chief Financial Officer, Mr. Roach, told him it was impractical because it would require the issuance of common stock at a cost of 13.5 percent to finance the purchase. Is the company following a logical approach to using its cost of capital. Solution: Rambo Exterminator Company No, each individual project should not be measured against the specific means of financing that project, but rather against the weighted average cost of financing all projects for the firm. This principle recognizes that the availability of one source of financing is dependent on other sources. Once a common overall cost is determined, the “colony destroying device” yielding 12 percent is much more likely to be accepted than the “bug eradicator” only yielding 7 percent. 11-2. Sullivan Cement Company can issue debt yielding 13 percent. The company is paying a 36 percent rate. What is the aftertax cost of debt? Solution: Sullivan Cement Company Kd = Yield (1 – T) = 13% (1 – .36) = 13% (.64) = 8.32%