Ground Hog Day, Inc., an unlevered firm, has one million shares of stock outstanding at a price of $20 per share. (The firms tax rate is 40%). The stock has a beta of 1.2, and the risk-free rate is 8%. (Assume that market risk premium = 6%). Management is considering the use of debt; debt would be issued and used to buy back stock. The firms analysts have estimated that the market yield on debt associated with three alternative debt levels is as follows:

Option # Value of Debt

(in millions) Yield to Maturity

%

Option 1 3 10%

Option 2 7 14%

Option 3 8 17%

The firm wants to use the cost of capital method for examining the three levels of debt.

Calculate the current cost of capital.

Answer for part 1

Calculate the levered beta for option 1

Answer for part 2

Calculate the levered beta for option 2

Answer for part 3

Calculate the levered beta for option 3

Answer for part 4

Calculate the cost of equity for option 1

Answer for part 5

Calculate the cost of equity for option 2

Answer for part 6

Calculate the cost of equity for option 3

Answer for part 7

Calculate the after-tax cost of debt for option 1

Answer for part 8

Calculate the after-tax cost of debt for option 2

Answer for part 9

Calculate the after-tax cost of debt for option 3

Answer for part 10

Calculate the weighted average cost of capital for option 1

Answer for part 11

Calculate the weighted average cost of capital for option 2

Answer for part 12

Calculate the weighted average cost of capital for option 3

Answer for part 13

Given the optimal debt level, what is the change in firm value in millions?

Answer for part 14

What is the stock price per share at the optimal debt level?