Qantas Airways Ltd has all-equity capital structure with the market value of equity of $2,500,000 and the cost of equity is 13%. The company is considering applying for a bank loan to finance a new project. The loan has a principal of $ 1,080,000; a 10-year term and a quoted rate of 6.5% p.a., and interest is paid annually.

 

The manager has asked you to conduct an analysis to demonstrate the impact of this borrowing on the capital structure, cost of capital and company's value, if the tax rate is 35%.

 

Required

a.        Base on M&M proposition II calculate the new cost of equity of the company after the debt issuance. 

b.        Calculate the present value of interest tax shield from the borrowing given the tax rate is 35%.