DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following combination of debt and equity to finance the investment.
? Issue $15 million of 20-year bonds at a price of $101, with a coupon rate of 8%, and flotation costs of 2% of par.
? Use $35 million of funds generated from earnings.
? The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is estimated to be .60. DQZ is subject to an effective corporate income tax rate of 40%.
The capital asset pricing model (CAPM) computes the expected return on a security by adding the risk-free rate of return to the incremental yield of the expected market return, which is adjusted by the company’s beta. Compute DQZ’s expected rate of return.