UU with a a. e. Assume, for economies of scale, that this project is 500 going to be financed entirely with debt. What would you use as your cost of capital for evaluating this project? nation: 3. Plastico is considering a major change in its capital struc- y rated ture. It has three options: Option 1: Issue $1 billion in new stock and repur- market chase half of its outstanding debt. This will make it an AAA-rated firm (AAA rated debt is yielding 11% in tstand- the marketplace) I share. ad has a Option 2: Issue $1 billion in new debt and buy back stock. This will drop its rating to A-(A-rated debt is yielding 13% in the marketplace). isk-free Option 3: Issue $3 billion in new debt and buy back stock. This will drop its rating to CCC (CCC rated debt is yielding 18% in the marketplace). in book What is the cost of equity under each option? b. What is the after-tax cost of debt under each this firm option? s? c. What is the cost of capital under each option? d. What would happen to (i) the value of the firm; (ii) the value of debt and equity; and (iii) the stock price under each option if you assume rational stockhold- -ct that re- ers? (You can assume no growth in perpetuity) ad has the e. From a cost of capital standpoint, which of the three ciation for options would you pick or would you stay at your forever): current capital structure? What role (if any) would the variability in Plastico's llion income play in your decision? & How would your analysis change (if at all) if the illion money under the three options were used to take million new investments (instead of repurchasing debt or million equity)? h. What other considerations (besides minimizing the the same cost of capital) would you bring to bear on your do- cision? expected to cipal repay. 1. Intuitively, why does not the higher rating in Option 1 translate into a lower cost of capital? lion UU with a a. e. Assume, for economies of scale, that this project is 500 going to be financed entirely with debt. What would you use as your cost of capital for evaluating this project? nation: 3. Plastico is considering a major change in its capital struc- y rated ture. It has three options: Option 1: Issue $1 billion in new stock and repur- market chase half of its outstanding debt. This will make it an AAA-rated firm (AAA rated debt is yielding 11% in tstand- the marketplace) I share. ad has a Option 2: Issue $1 billion in new debt and buy back stock. This will drop its rating to A-(A-rated debt is yielding 13% in the marketplace). isk-free Option 3: Issue $3 billion in new debt and buy back stock. This will drop its rating to CCC (CCC rated debt is yielding 18% in the marketplace). in book What is the cost of equity under each option? b. What is the after-tax cost of debt under each this firm option? s? c. What is the cost of capital under each option? d. What would happen to (i) the value of the firm; (ii) the value of debt and equity; and (iii) the stock price under each option if you assume rational stockhold- -ct that re- ers? (You can assume no growth in perpetuity) ad has the e. From a cost of capital standpoint, which of the three ciation for options would you pick or would you stay at your forever): current capital structure? What role (if any) would the variability in Plastico's llion income play in your decision? & How would your analysis change (if at all) if the illion money under the three options were used to take million new investments (instead of repurchasing debt or million equity)? h. What other considerations (besides minimizing the the same cost of capital) would you bring to bear on your do- cision? expected to cipal repay. 1. Intuitively, why does not the higher rating in Option 1 translate into a lower cost of capital? lion
