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current yield to maturity on the annot be directly observed in a * uses its WACC as the de ness and each present ulti-divisional division is in the firm projer w per (Use the following information for the next 3 questions) As the manager of a private fund, you are considering a leveraged buy out of a target company. The target company currently has $400 million debt and 5600 million equity.ie debt ratio of 40%. The currem debt market condition prevents you from raising the debt ratio over 60%. To maximize retum for your fund, you are considering choosing the optimal capital structure from two possible debt ratios, 40% or 60% . Since the company has invested in all positive NPV projects, you do not want to change the amount of total assets. Therefore, if you decide to borrow more debt, the proceeds will be used to buy back stock. The credit rating is determined by EBIT coverage ratio (see Exhibit 1). The interest rate of all debt is tied to credit rating (see Exhibit 2). Your company is expected to maintain EBIT of $85 million Your current rating is A, which corresponds to an interest rate of 4.71% Current stock beta (levered beta) is 1.79. The risk free rate is 4% and the market risk premium is 5%. You company faces a marginal tax rate of 30% Exhibit 1 Exhibit 2 Default Spread If EBIT COV E BIT CO Sto Rating is Rating in basis points) 8.50 100000 AAA AAA 6.5 8.5 AA AA 5.5 6.5 A+ 45 5.5 4.5 A- BBB BBB 2.5 BB+ BB+ BB BB 330 1.75 B+ 395 1.5 1.75 720 1.25 1.5 1375 1600 0.65 0.8 1800 2000 -100000 0.2 A- 265 B+ 0.8 1.25 0.2 0.65 ivisid - separo ans 13. If debt ratio is increased to 60%, the EBIT coverage ratio of the company will be reduced to 2.74. What will be the cost of debt? A. 2.74% B. 4.71% C. 4.84% D. 5.17% ** E. Cannot be determined 14. What is the unlevered beta of your common stock? A. 1.79 B. 1.55 C. 1.22** D. 1.05 E. 0.89 15. Which capital structure has a lower WACC? A. 40% debt B. 60% debt** C. WACC is the same under both capital structures D. Not enough information to calculate WACC Indor 10% deht