CfQuiz3a

1. Beltran Enterprises is a publicly traded transportation firm with 80 million shares outstanding, trading at $25 a share and $ 500 million in debt. The firm has $120 million in operating income (EBIT), its current cost of equity is 10% and its current rating is A (with a default spread of 2% over the riskfree rate). The current riskfree rate is 4%, the marginal tax rate is 40% and the equity risk premium is 5%.

a. Estimate the current cost of capital for the firm.

CfQuiz3a

b. Now assume that the firm is considering tripling its dollar debt and buying back stock. If this action will lower the bond rating to B and increase the default spread to 6%, estimate the interest expenses at the new debt level and the tax rate to use to compute the after-tax cost of debt.

CfQuiz3a

c. If the firm does triple its dollar debt and buys back stock, estimate the new cost of capital for the firm.