Question 1.

You are a corporate finance analyst at a management consulting firm, which has been approached by a company for advice on its capital structure decisions. The company, Boston Turkey Inc., has been in existence for only two years, and its stock is currently trading at $20 per share (There are 100,000 shares outstanding.) The following are the most recent financial statements of the company:

Income Statement

Revenues

$1,000,000

Expenses

$400,000

Depreciation

$100,000

EBIT

$500,000

Interest Expense

$100,000

Taxable Income

$400,000

Tax

$160,000

Net Income

$240,000

Balance Sheet

Current Assets

$1,000,000

Accounts payable

$500,000

Land & Buildings

$500,000

Long Term Debt

$1,000,000

Property, Plant & Equipment

1,500,000

Equity (100,000 shares)

$1,500,000

Total Assets

$3,000,000

Total Liabs. & Equity

$3,000,000

Due to its limited history, the beta of the stock cannot be estimated from past prices. You do have information about comparable listed firms and their betas

Firm

Beta

Debt/Equity Ratio

Arizonas Baked Chicken

1.05

20%

Barbees Chicken

1.20

50%

Eyepops Chicken

0.90

10%

Bob Roy Chicken & Fish

1.35

70%

Question 1.

You are a corporate finance analyst at a management consulting firm, which has been approached by a company for advice on its capital structure decisions. The company, Boston Turkey Inc., has been in existence for only two years, and its stock is currently trading at $20 per share (There are 100,000 shares outstanding.) The following are the most recent financial statements of the company:

Income Statement

Revenues	$1,000,000
Expenses	$400,000
Depreciation	$100,000
EBIT	$500,000
Interest Expense	$100,000
Taxable Income	$400,000
Tax	$160,000
Net Income	$240,000
Balance Sheet
Current Assets	$1,000,000	Accounts payable	$500,000
Land & Buildings	$500,000	Long Term Debt	$1,000,000
Property, Plant & Equipment	1,500,000	Equity (100,000 shares)	$1,500,000
Total Assets	$3,000,000	Total Liabs. & Equity	$3,000,000

Due to its limited history, the beta of the stock cannot be estimated from past prices. You do have information about comparable listed firms and their betas

Firm	Beta	Debt/Equity Ratio
Arizonas Baked Chicken	1.05	20%
Barbees Chicken	1.20	50%
Eyepops Chicken	0.90	10%
Bob Roy Chicken & Fish	1.35	70%

(The comparable firms all have the same tax rate as Boston Turkey). You can assume that the market risk premium is 5.5%.

As general information, you have also collected data on interest coverage ratios, ratings and interest rate spreads, and they are summarized below:

Rating	Coverage Ratio greater than	and Coverage Ratio less than	Spread over T-bond
AAA	9.65		0.30%
AA	6.85	9.35	0.70%
A+	5.65	6.85	1.00%
A	4.49	5.65	1.25%
A-	3.29	4.49	1.50%
BBB	2.76	3.29	2.00%
BB	2.17	2.76	2.50%
B+	1.87	2.17	3.00%
B	1.57	1.87	4.00%
B-	1.27	1.57	5.00%
CCC	0.87	1.27	6.00%
CC	0.67	0.87	7.50%
C	0.25	0.67	9.00%
D	-100000	0.25	12.00%

The treasury bill rate is 3.00% and the treasury bond rate is 6.25%.

What is the current cost of equity?

What is your best estimate of the current after-tax cost of debt? (The company is not rated

currently). Justify your answer.

What is the current cost of capital?

As part of your analysis, you are examining whether Boston Turkey should borrow

$500,000 and buy back stock. If it does so, its rating will drop to A-. If it does so,

what will the new cost of equity be?

How much will the stock price change if it borrows $500,000 and buys back stock?