Credit rating, and interest rate? (Hint: Compute the EBIT coverage ratio using the
current interest rate. Based on this ratio, find the corresponding credit rating and
new interest rate. Then compute the EBIT coverage ratio again with the new
interest rate. Repeat this procedure until the EBIT coverage ratio, credit rating,
and interest rate are lined up in the same row.) (5 points)
The size (total value) of the firm is $200m
debt + $800m equity = $1b. The
size will remain unchanged.
@ 30% debt, assuming current interest,
interest expense is $300m * 4.3% = $12.9m
EBIT coverage = $80m/$12.9m = 6.2, which corresponds to A+ rating
@ A+ rating, the interest increases to 4.63% (Rf + default spread of A+
rating)
Interest expense is $300m * 4.63% = $13.89m
EBIT coverage = $80m/$13.89m = 5.76, which still corresponds to A+
rating.
Therefore, at 30% debt ratio, you will have EBIT coverage ratio of 5.76,
credit rating of A+, and interest rate of 4.63%.
b)
What will be the EBIT coverage ratio, credit rating, and interest rate if the debt
ratio is 40%? (5 points)
@ 40% debt, assuming current interest,
interest expense is $400m * 4.3% = $17.2m
EBIT coverage = $80m/$17.2m = 4.65, which corresponds to A rating
@ A rating, the interest increases to 4.71% (Rf + default spread of A rating)
Interest expense is $400m * 4.71% = $18.84m
EBIT coverage = $80m/$18.84m = 4.246, which corresponds to A
rating.
@ A rating, the interest increases to 4.84% (Rf + default spread of A
rating)
Interest expense is $400m * 4.84% = $19.36m
EBIT coverage = $80m/$19.36m = 4.132, which still corresponds to A
rating.
Therefore, at 40% debt ratio, you will have EBIT coverage ratio of 4.132,
credit rating of A, and interest rate of 4.84%.
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c)
What is the unlevered beta of your common stock? (5 points)
The stock beta of 1.5 is the levered beta at the D/E ratio of 0.25 ($200m/
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 Fall '09
 SA'EED
 Debt, Weighted average cost of capital, Credit rating, EBIT coverage ratio

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