Question 5

Pennsylvania Steel, one of the largest steel companies in the united States, is considering whether it has any excess debt capacity. The company has $527 million in market value of debt outstanding and $1.76 billion of market value of equity. The company has EBIT of $131 million and faces a corporate tax rate of 36%. The companys bonds are rated BBB, and the cost of debt is 8%. At this rating the company has a probability of default of 2.30%, and the cost of bankruptcy is estimated to be 30% of firm value.

Estimate the unlevered value of the firm. Estimate the levered value of the firm using the APV approach, at a debt ratio of 50%. At that debt ratio, the firms bond rating will be CCC, and the probability of default will increase to 30%.