Road King Trucks case paper help part 3: Financing Assumptions

Exhibit 3: Financing Assumptions The following assumptions are used to determine the cost of capital. Historically, the company has maintained a debt ratio is 50%. This ratio was used, because lowering the debt implies giving up the debt tax shield, and increasing it makes debt service a burden on the firm's cash flow. In addition, increasing the debt level may cause a reduced rating of the company's bonds. The marginal tax rate is 40%. All the numbers are expressed in today's dollars. The forecasted average inflation per year is 2.5%. Cost of debt: The company's bond rating is roughly at the high end of the A range. Surveying the debt market yielded the following information about the cost of debt for different rating levels: Bond rating BBB Interest cost range 5.5% -6.5% 6.25% -7.5% 7.5% -9% The company's current bonds have a yield to maturity of about 6.5%. AA A Cost of equity: The current 10-year Treasury notes have a yield to maturity of 1.75% and the forecast for the S&P 500 market premium is 9.75%. The company's overall Bis 1.25