) Salvatore Inc. is a motion picture production company. At the end of its most recent financial year, the firm had $ 500 million in interest bearing debt on its books (with interest payments of $ 35 million a year and an average maturity of 8 years). The firm has a rating of B + and a pre-tax cost of debt of 8%. There are 50 million shares trading at $ 6 per share and the levered beta for the firm is 2.25. The tax rate is 40%, the risk free rate is 4% and the market risk premium is 4.82%. a. Estimate the current cost of capital for the firm. b. Assume now that Salvatore Inc. is able to issue enough stock to retire half of its outstanding debt (in market value terms). If the stock price does not change after this transaction, estimate the pre-tax cost of debt after the transaction.
) Salvatore Inc. is a motion picture production company. At the end of its most recent financial year, the firm had $ 500 million in interest bearing debt on its books (with interest payments of $ 35 million a year and an average maturity of 8 years). The firm has a rating of B + and a pre-tax cost of debt of 8%. There are 50 million shares trading at $ 6 per share and the levered beta for the firm is 2.25. The tax rate is 40%, the risk free rate is 4% and the market risk premium is 4.82%. a. Estimate the current cost of capital for the firm. b. Assume now that Salvatore Inc. is able to issue enough stock to retire half of its outstanding debt (in market value terms). If the stock price does not change after this transaction, estimate the pre-tax cost of debt after the transaction.
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:) Salvatore Inc. is a motion picture production company. At the end of
its most recent financial year, the firm had $ 500 million in interest
bearing debt on its books (with interest payments of $ 35 million a
year and an average maturity of 8 years). The firm has a rating of B +
and a pre-tax cost of debt of 8%. There are 50 million shares trading
at $ 6 per share and the levered beta for the firm is 2.25. The tax rate
is 40%, the risk free rate is 4% and the market risk premium is
4.82%.
a. Estimate the current cost of capital for the firm.
b. Assume now that Salvatore Inc. is able to issue enough stock to
retire half of its outstanding debt (in market value terms). If the stock
price does not change after this transaction, estimate the pre-tax cost
of debt after the transaction.
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