This question is also about NZ Products Ltd, the same company as in Question 2.

Your boss now asks you to evaluate the companys cost of capital. To finance the new product, NZ Products Ltd has $3,500,000 in profits that it can use and plans to raise the remaining amount through a bond issue (i.e., debt). The decision to use so much debt financing for the project was largely due to the argument by the CEO, Paul Lowe, that debt financing is cheaper relative to ordinary shares (which the firm has used in the past). However, this has raised some concern over what cost of capital to use for the new project. Your boss knows that if the firm uses debt now it will eventually have to use equity in the future if it wants to maintain the balance of debt and equity it has in its capital structure. Historically, the firm has used 40% debt and 60% equity as the financing mix. Of course, these percentages vary over time, but the firm intends to maintain this mix for the foreseeable future. NZ Products Ltd's average yield to maturity is currently 9%, its beta is 1.59, the risk-free rate is 3% and the market return is 10%.

a. What is NZ Products Ltd's cost of debt? Show your workings.

b. What is NZ Products Ltd's cost of equity? Show your workings.

c. Which financing mix should you use to calculate the weighted average cost of capital to evaluate the new project? Explain why.

d. Calculate the weighted average cost of capital (WACC). Show your workings.

e. Compare the WACC you calculated in part d to the cost of capital used in question 2. Would it affect your recommendation in question 2e about whether to accept or reject the new product proposal?