(Cost of capital, capital structure, leveraged and unleveraged betas) Hugo Boss AG is a German luxury fashion and style house that is examining its financing policy for possible changes. The firm has 8-year coupon bonds outstanding with a face value of $ 400 million and interest expenses of $18.0 million a year. This is the only debt obligation, the company has. The firm is rated BB and the default spread (on top of risk free rate) for BB rated bonds is 4.2%. There are 20 million shares trading at $10 a share and the current levered beta for the firm is 1.80. The risk-free rate is 3% and the market risk premium is 6%. The corporate tax rate for the firm is 40%.

Questions:

a. Estimate the market value of outstanding debt at the firm today.

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

The company believes that it could lower its cost of capital by moving to debt to capital (D/A) ratio of 50%. The company predicts that this move could lower its pre-tax cost of debt by 2 percentage points.

c. Calculate the new cost debt and equity if the change in capital structure is.