Airlift is a Pakistani app-based decentralized urban mass transit startup that allows customers to book fixed rate rides on buses and vans in their network. The idea of Airlift was conceived by the founding Chief Executive Usman Gul after he experienced the congestion during his visit to Lahore for vacations which was caused by the inefficiency of local transportation. Due to COVID crisis and other pre-COVID issues, Airlift had been struggling with high cost of capital that inhibited its ability to make any capital investments. Since you have taken FINN 100 at LUMS, Usman Gul has hired you to solve the financial problems faced by Airlift. On the first day at office you realize that capital costs have now started declining. To solve the pre and post COVID issues faced by the company, you recommend a major expansion of services offered by Airlift. Before higher management of Airlift discusses your plan, you first need to calculate Airlift's cost of capital. You can assume that the firm's tax rate is 40 percent. You are also told by the finance department that the current price of Airlift's 12 percent coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is PKR 1153.72. Airlift does not use short- term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firm's 10 percent, PKR 100 par value, quarterly dividend, perpetual preferred stock is PKR 113.10. Airlift would incur flotation costs of PKR 2 per share on a new issue. Airlift's common stock is currently selling at PKR 50 per share. Its last dividend (D) was PKR 4.19, and dividends are expected to grow a constant rate of 5 percent in the foreseeable future. Airlift's beta is 1.2; the yield on T-Bonds is 7 percent; and the market risk premium is estimated to be 6 percent. For the bond-yield-plus-risk-premium approach, the firm uses a 4 percentage point risk premium. Airlift's target capital structure is 30 percent long term debt, 10 percent preferred stock and 60 percent common equity. Based on the above information, answer the following questions: Question 5 - What is the market interest rate on Airlift's debt and its component cost of debt? [5 Marks) Question 6 - Would you include flotation costs? Give justification for your answer. [2 Marks) Question 7 - What is the effective annual cost? [2 Marks] Question 8 - What is Airlift's cost of preferred stock? [5 Marks] Question 9 - Airlift's preferred stocks are riskier from perspective of investors as compared to its debt. But preferred stock's yield to investors is lower than the yield to maturity on the debt. Usman Gul thinks you made a mistake. Is he right? [10 Marks)
