Question: NYNEX the phone utility for the New York City area

NYNEX, the phone utility for the New York City area, has approached you for advice on its capital structure.
In 1995, NYNEX had debt outstanding of $12.14 billion and equity outstanding of $20.55 billion. The firm had an EBIT of $1.7 billion and faced a corporate tax rate of 36%. The beta for the stock is 0.84, and the bonds are rated A−(with a market interest rate of 7.5%). The probability of default for A—rated bonds is 1.41%, and the bankruptcy cost is estimated to be 30% of firm value.
a. Estimate the unlevered value of the firm.
b. Value the firm, if it increases its leverage to 50%. At that debt ratio, its bond rating would be BBB and the probability of default would be 2.30%.
c. Assume now that NYNEX is considering a move into entertainment, which is likely to be both more profitable and riskier than the phone business. What changes would you expect in the optimal leverage?

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  • CreatedApril 15, 2015
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