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Capital structure practice(1)

Company will still have enough cash reserve to pay

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company will still have enough cash reserve to pay the principal of your loan, but you are worried about the agency cost of financial distress. What actions the company may take in financial distress that will put your loan money in risk? What actions will you take to prevent these destructive behaviors?
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4. Your company currently has $200 million debt and $800 million equity. Several bond covenants prevent you from retiring the existing debt and the maximum debt ratio is limited to 40%. To maximize firm value, you are considering choosing the optimal capital structure from three possible debt ratios, 20%, 30%, or 40%. Since the company has invested in all positive NPV projects, you do not want to change the amount of total assets. Therefore, if you decide to borrow more debt, the proceeds will be used to buy back stock. The interest rate (default spread) of all debt is tied to credit rating (see Exhibit 1). The credit rating is determined by EBIT coverage ratio (see Exhibit 2). Your company is expected to maintain EBIT of $80 million. Your current rating is AAA, which corresponds to an interest rate of 4.3%. Current stock beta (levered beta) is 1.5. The risk free rate is 4% and the market risk premium is 5%.
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