Exhibit 3: Financing Assumptions The following assumptions are used to determine the cost of capital Historically, the company tried to maintain a debt ratio equal to 0.28. This ratio was used, because lowering the debt implies giving up the debt tax shield, and increasing it makes debt service a burden on the firm's cash flow. In addition, increasing the debt level may cause a reduced rating of the company's bonds. The marginal tax rate is 40%. All the numbers are expressed in today's dollars. Cost of debt: The company's bond rating is roughly at the high end of the A range. Surveying the debt market yielded the following information about the cost of debt for different rating levels Bond rating ВВB AA A Interest cost range 6% 7% 5% - 6 % 7%~8.5% Cost of equity: The current 10-year Treasury notes have a yield to maturity of 3% and the forecast for the S&P 500 market premium is 6%. The company's overall ß is 1.2 Banalysis General Universal Transports Inc. Trucks International Road King Company Red Trucks Trucks Bird Trucks Overall B 1.2 1.2 13 1.32 1.2 1.09 Debt to equity 0.4 0.3 0.5 0.45 0.35 0.25 Percentage of 50 45 90 95 85 85 income from trucks
Exhibit 3: Financing Assumptions The following assumptions are used to determine the cost of capital Historically, the company tried to maintain a debt ratio equal to 0.28. This ratio was used, because lowering the debt implies giving up the debt tax shield, and increasing it makes debt service a burden on the firm's cash flow. In addition, increasing the debt level may cause a reduced rating of the company's bonds. The marginal tax rate is 40%. All the numbers are expressed in today's dollars. Cost of debt: The company's bond rating is roughly at the high end of the A range. Surveying the debt market yielded the following information about the cost of debt for different rating levels Bond rating ВВB AA A Interest cost range 6% 7% 5% - 6 % 7%~8.5% Cost of equity: The current 10-year Treasury notes have a yield to maturity of 3% and the forecast for the S&P 500 market premium is 6%. The company's overall ß is 1.2 Banalysis General Universal Transports Inc. Trucks International Road King Company Red Trucks Trucks Bird Trucks Overall B 1.2 1.2 13 1.32 1.2 1.09 Debt to equity 0.4 0.3 0.5 0.45 0.35 0.25 Percentage of 50 45 90 95 85 85 income from trucks
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
Related questions
Question
100%
What is the company’s cost of capital?
1.
r rf = risk-free rate of return = 10-year Treasury rate = 3%
S&P market premium (in parenthesis) is the extra return to cover risk offered in the stock market = 5%. B = Beta of company = 1.2
2. WACC = wdrd(1-t) + were = weighted average cost of capital
Weights of debt and equity: Given debt ratio, that is, debt to total assets = 28%. Cost of debt is bond rating at high end of A average = 6%. Tax rate given 40%.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 2 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education