Unlevered Beta Levered Beta/ [1 + (Debt/Equity)*(1 Tax Rate)] Firm A Unlevered Firm B Unlevered Un-levered, all equity beta 0.86/(1+0*(1-.4)] 1.73/[1+.36*(1-.4)] (.86 +1.42)/2 = 0.86 = 1.42 = 1.14 Seven Scenarios 1 - No debt 2 - 10% debt 3 - 20% debt 4- 30% debt 5 - 40% debt 6 - 50% debt 7 -60% debt Amount Borrowed $0 $200,000 $400,000 $600,000 $800,000 $1,000,000 $1,200,000 Debt Rating BBB BBB BB B CCC CC Debt Risk Premium 0.65% 0.65% 1.75% 2.75% 4.00% 5.00% 6.00% d. What will be the after-tax cost of debt under each scenario? Cost of Debt = (Treasury Bond Rate + Risk Premium) * (1 - Tax Rate) 2 7 3 4 5 6 Scenario 1 After Tax Interest Rate 3.09% % % % % % %