FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
10th Edition
ISBN: 9781259964947
Author: Libby
Publisher: MCG
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Question
Consider the following data towards a firm's potential leverage. Assume
that the firm can lever up in increments of 10% of firm value upto 60%
debt in the capital mix. Further assume that the CAPM holds. How much
debt should the firm use to minimize its financing cost?
Corporate Income tax rate
Asset beta
45%
1.2
Treasury instrument rate
Expected return on market portfolio
6%
10%
Debt/Value Credit rating for the debt
Credit spread
0% AAA
2%
10% AA
4%
20% A
6%
30% A-
8%
40% BAA
10%
50% BBA
14%
60% BBB
20%
>60% Junk
Credit not available
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Transcribed Image Text:Consider the following data towards a firm's potential leverage. Assume that the firm can lever up in increments of 10% of firm value upto 60% debt in the capital mix. Further assume that the CAPM holds. How much debt should the firm use to minimize its financing cost? Corporate Income tax rate Asset beta 45% 1.2 Treasury instrument rate Expected return on market portfolio 6% 10% Debt/Value Credit rating for the debt Credit spread 0% AAA 2% 10% AA 4% 20% A 6% 30% A- 8% 40% BAA 10% 50% BBA 14% 60% BBB 20% >60% Junk Credit not available
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