Company ABC, a social media firm, has the following characteristics: There are 200 million shares outstanding, trading at $100 per share. The firm has a book value of debt $50 billion (with a maturity of 10 years) and interest expenses of $1 billion on the debt. The firm is not rated, but it has operating income of 2.5 billion last year. The tax rate for the firm is 30%. ● ● ● ● The equity risk premium is 6% The estimated bond ratings and the corresponding default spreads for various ranges of interest coverage ratio are:
Company ABC, a social media firm, has the following characteristics: There are 200 million shares outstanding, trading at $100 per share. The firm has a book value of debt $50 billion (with a maturity of 10 years) and interest expenses of $1 billion on the debt. The firm is not rated, but it has operating income of 2.5 billion last year. The tax rate for the firm is 30%. ● ● ● ● The equity risk premium is 6% The estimated bond ratings and the corresponding default spreads for various ranges of interest coverage ratio are:
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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Transcribed Image Text:Question 6
Company ABC, a social media firm, has the following characteristics:
There are 200 million shares outstanding, trading at $100 per share.
The firm has a book value of debt $50 billion (with a maturity of 10 years) and
interest expenses of $1 billion on the debt. The firm is not rated, but it has
operating income of 2.5 billion last year.
The tax rate for the firm is 30%.
●
●
The equity risk premium is 6%
The estimated bond ratings and the corresponding default spreads for various
ranges of interest coverage ratio are:
Interest Coverage Ratio Estimated Bond Rating
> 4.79
AAA
AA
A+
BBB
BB+
3.70 4.79
3.00-3.69
2.00 - 2.99
< 2.0
Default Spread
b) Estimate the market value of debt for ABC.
c) Estimate the cost capital for ABC.
0%
0.5%
1%
1.5%
2%
The Treasury bond rate is 6%, and the unlevered beta of other social media firms is 1.0.
a) Based on the estimated synthetic rating, calculate the pre-tax cost of debt for
ABC.
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