Pfizer, one of the largest pharmaceutical companies in the United States, is considering what its debt capacity is. In March 1995, Pfizer had an outstanding market value of equity of $24.27 billion, debt of $2.8 billion, and an AAA rating. Its beta was 1.47, and it faced a marginal corporate tax rate of 40%. The Treasury bond rate at the time of the analysis was 6.50% and AAA bonds trade at a spread of 0.30% over the Treasury rate.

a. Estimate the current cost of capital for Pfizer.

b. It is estimated that Pfizer will have a BBB rating if it moves to a 30% debt ratio and that BBB bonds have a spread of 2% over the Treasury rate. Estimate the cost of capital if Pfizer moves to its optimal.

c. Assuming a constant growth rate of 6% in the firm value, how much will firm value change if Pfizer moves its optimal? What will the effect be on the stock price?

d. Pfizer has considerable R&D expenses. Will this fact affect whether Pfizer takes on the additional debt?