Question 1: The Millennium Charitable Foundation, which is tax-exempt, issued debt last year at 8 percent to help finance a new playground facility in Chicago. This year the cost of debt is 15 percent higher; that is, firms that paid 10 percent for debt last year would be paying 11.5 percent this year.
A. If the Millennium Charitable Foundation borrowed money this year, what would the after tax cost of the debt be, based on its cost last year and the 15 percent increase?
B. If the foundation was found to be taxable by the IRS (at a rate of 35 percent) because it was involved in political activities, what would the after tax cost of the debt be?
Question 2. Mary Ott Hotels wants to determine the minimum cost of capital point for the firm. Assume it is considering the following financial plans:
Cost (after tax) Weights
Plan A
Debt..................... 6.0% 20%
Preferred stock......... 10.0 10
Common equity............ 13.0 70
Plan B.
Debt.......................... 6.5% 30%
Preferred stock............. 10.5 10
Common equity............ 13.5 60
Plan C.
Debt........................ 7.0% 40%
Preferred stock............ 10.7 10
Common equity.......... 14.2 50
Plan D.
Debt........................ 9.0% 50%
Preferred stock............ 11.2 10
Common equity.......... 16.0 40