Question
A & B is a book retailer, that earned $ 1 billion before interest and taxes, but after $ 300 million in operating lease expenses
A & B is a book retailer, that earned $ 1 billion before interest and taxes, but after $ 300 million in operating lease expenses last year; the firm has commitments to make $ 300 million in lease payments every year for the next 6 years. The firm had interest expenses of $ 100 million on 5 year convertible debt with a face value (book value) of $ 2 billion; the bonds trade at a market value of $ 2.5 billion. Assume that A&B is rated BBB, and that the default spread on BBB rated bonds is 2% over the treasury bond rate. Finally, the firm also had 300 million shares outstanding, trading at $ 10 per share. The stock has a beta of 1.25, the tax rate is 27% and the treasury bond rate is 3.5% (Market risk premium = 5.39%).
Estimate the market value of the debt in this firm.
Estimate the cost of capital for this firm.
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