Optimist Company can sell common shares at $30 per share and can obtain debt funding at 8 percent. It has a marginal income tax rate of 25 percent. The yield on US Treasury securities is 3 percent. The market risk premium is 6.0 percent, and the firm's beta is 0.9. It has a targeted debt-to-equity ratio of 1:1. What is its after-tax cost of debt?

Optimist Company can sell common shares at $30 per share and can obtain debt funding at 8 percent. It has a marginal income tax rate of 25 percent. The yield on US Treasury securities is 3 percent. The market risk premium is 6.0 percent, and the firm's beta is 0.9. It has a targeted debt-to-equity ratio of 1:1. What is its after-tax cost of debt?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Jaguar Holdings Company can obtain debt funding at 8 percent. Its marginal income tax rate is 25 percent. The yield on US Treasury securities is 3 percent. The market risk premium is 6.0 percent, and the firm’s beta is 2. It has a targeted debt-to-equity ratio of 1:1 (25 percent debt, 75 percent equity). 1) What is its weighted average cost of capital? Jaguar Holdings Company must choose between solar and an electric-powered forklift truck for moving materials in its factory. Because both forklifts perform the same function, the firm will choose only one. (They are mutually exclusive investments.) The solar truck will cost more but will be less expensive to operate; it will cost $80,000, whereas the electric-powered truck will cost $70,000. The life for both types of truck is estimated to be 10 years, during which time the net cash flows for the solar-powered truck will be $20,000 per year, and those for the electric-powered truck will be $12,000 per year. 2) Calculate the NPV…
Your firm has a WACC of 16.25%. The cost of equity is 20% and the firm's bonds yield 7.9%. The tax rate is 30%. What is the firm's D/E ratio?
TransPacific Inc. is an import-export company specializing in products from Asia and the West Coast. It can borrow in the debt market at 9%. Its cost of equity with 40% DN ratio is 13%. Its corporate tax rate is 20%. If the M&M world of taxes holds true, what is the WACC for TransPacific Inc. with a 40% DIV financing? A. 9.44% B. 8.00% C. 10.68% D. 7.80%
The beta of Kimberly – Clark firm is now 0.91 and the Debt-to-Equity ratio is 12%. Assume that Kimberly - Clark is planning to increase its Debt-to-Equity ratio to 30%. Given that the corporate tax rate is 40%, its new beta will be: A. 1.00 B. 0.86 C. 0.95 D. 1.2 E. None of the above
A firm's unlevered beta is 0.5 and tax rate is 30%. If it is with 20% debt. What is the firm's levered beta? 0.9012 1.2533 0.5875 0.6235
A firm's stock has a beta of 1.75, Treasury bills yield 3.8%, and the market portfolio offers an expected return of 9.5%. In addition to equity, the firm finances 26% of its assets with debt that has a yield to maturity of 7.4%. The firm is in the 28% marginal tax bracket. What is the company’s after tax cost of debt?
Blue Shoe Inc.'s pre-tax cost of debt amount to 4%. The company has a 30/70 debt to equity split. The risk-free rate is 0.5%, the equity (market) risk premium is 5.5% and the tax rate is 30%. If Blue Shoe Inc.'s WACC amount to 7%, what must its unlevered beta be?
A company is considering its optimal capital structure. The firm currently has 1 million shares outstanding at $ 20 per share (tax rate = 40%) and a debt balance of $5 million. Currently, its (levered) beta is 1.5 and its ERP is 5.5%. The current risk-free rate is 5%. Your research indicate the following ratings and pre-tax cost of debt across the different debt ratios: D/(D+E) Rating Pre-tax cost of debt 0% AAA 10% 10% AA 10.5% 20% A 11% 30% BBB 12% 40% BB 13% 50% B 14% 60% CCC 16% 70% CC 18% 80% C 20% 90% D 25% a. Using the optimal WACC approach, what is the firm's optimal debt ratio? b. Calculate the company's unlevered value, assuming that the probability of default is 5% and the company loses 30% of its value in the event of a default.
Clifford Chance is a large U.K. firm with the before tax cost of debt of 10%. The risk-free rate of interest on 10-year Treasury bonds is 4%. The expected return on the market portfolio is 8%. After effective taxes, Clifford Chance’s effective tax rate is 20%. Its optimal capital structure is 70% debt and 30% equity. If Clifford Chance’s beta is estimated at 1.5, what is its weighted average cost of capital? (4 marks) This firm has collected 50,000 GBP from U.K. stock and bond markets by using the weighted average cost of capital calculated in step (a). It has invested this fund on a 3-year project in U.K. and earned the cash flows of 10,000, 15,000, and 20,000 for the first, second, and third years of the project, respectively. Calculate Net Present Value of the project and provide a decision whether this project is acceptable for investment?
Rolex, Inc. has equity with a market value of $20 million and debt with a market value of $10 million. Assume the firm has no default risk and can borrow at the risk-free interest rate. The risk-free interest rate is 5 percent per year, and the expected return on the market portfolio is 11 percent. The beta of the company's equity is 1.2. The tax rate is 20%. What is the cost of capital for an otherwise identical all-equity firm?
Corcovado Pharmaceuticals. Corcovado Pharmaceutical’s cost of debt is 7%. The risk-free rate of interest is 3%. The expected return on the market portfolio is 8%. After effective taxes, Corcovado’s effective tax rate is 25%. Its optimal capital structure is 60% debt and 40% equity. If Corcovado’s beta is estimated at 1.1, what is its weighted average cost of capital? If Corcovado’s beta is estimated at 0.8, significantly lower because of the continuing profit prospects in the global pharma sector, what is its weighted average cost of capital?
Mint Industries has a target debt-equity ratio of 0.60, a cost of equity of 10%, and one issue of bonds that are offering a yield to maturity of 7.67%. If Minder’s tax rate is 40%, what is the company’s WACC?

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