Corporate Finance: Quiz 3
This quiz is worth 10% and you have 30 minutes.
1. 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 20%. The long term treasury bond rate is 7%. ( 5 points)
Debt Ratio |
10% |
20% |
Extra Column |
$ 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% |
2. CSL Corporation is a mid-sized transportation firm with 10 million shares outstanding, trading at $ 25 per share and debt outstanding of $ 50 million. It is estimated that the cost of capital, which is currently 11%, will drop to 10%, if the firm borrows $ 100 million and buys back stock. Estimate the expected change in the stock price if the expected growth rate in operating earnings over time is 5%.