You have been provided the information on the after-tax cost of debt and cost of capital that a company will have at a 10% debt ratio, and asked to estimate the after-tax cost of debt and cost of capital at 30%. The long term treasury bond rate is 7%.

Debt Ratio 10% 30%

$ Debt $ 1,500

EBIT $ 1,000

Interest Expenses $ 120

Interest Coverage Ratio 8.33

Bond Rating AA

Interest Rate 8.00%

After-tax Cost of Debt 4.80%

Beta 1.06

Cost of Equity 12.83%

Cost of Capital 11.78%

The interest coverage ratios, ratings and spreads are as follows:

Coverage Ratio Rating Spread over Treasury

> 10 AAA 0.30%

7 -10 AA 1.00%

5 - 7 A 1.50%

3 - 5 BBB 2.00%

2- 3 BB 2.50%

1.25 - 2 B 3.00%

0.75 - 1.25 CCC 5.00%

0.50 - 0.75 CC 6.50%

0.25 - 0.50 C 8.00%

0.25 D 10.00%

a.

13.28%

b.

10.56%

c.

11.42%

d.

5.98%

SHOW WORK PLEASE