1. You have to make a decision on how much your company can afford to borrow....

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1. You have to make a decision on how much your company can afford to borrow. The company currently has 10 million shares outstanding, and the market price is $50 per share. The company also currently has about $200 million in debt outstanding (at market value). The company is rated as a BBB corporation now. The company stock has a beta of 1.5 and the six-month T-Bill rate is 8%. The company's marginal tax rate is 46%. You estimate that the company's rating will change to a B if the company borrows $100 million. The BBB rate now is 11%. The B rate is 12.5%. a. Given the marginal costs and benefits of borrowing the $100 million, should the company go ahead with it? b. What is your best estimate of the weighted average cost of capital with and without the $100 million in borrowing? c. If the company borrows the $100 million, what will the price per share be after the borrowing? d. Assume that the company has a project that requires an investment of $100 million. It has expected before-tax revenues of $50 million, and costs of $30 million a year in perpetuity. Is this a desirable project? Why or why not? e. Does it make a difference in your decision if you were told that the cash flows from the project in d. are certain? (18 marks) 1. You have to make a decision on how much your company can afford to borrow. The company currently has 10 million shares outstanding, and the market price is $50 per share. The company also currently has about $200 million in debt outstanding (at market value). The company is rated as a BBB corporation now. The company stock has a beta of 1.5 and the six-month T-Bill rate is 8%. The company's marginal tax rate is 46%. You estimate that the company's rating will change to a B if the company borrows $100 million. The BBB rate now is 11%. The B rate is 12.5%. a. Given the marginal costs and benefits of borrowing the $100 million, should the company go ahead with it? b. What is your best estimate of the weighted average cost of capital with and without the $100 million in borrowing? c. If the company borrows the $100 million, what will the price per share be after the borrowing? d. Assume that the company has a project that requires an investment of $100 million. It has expected before-tax revenues of $50 million, and costs of $30 million a year in perpetuity. Is this a desirable project? Why or why not? e. Does it make a difference in your decision if you were told that the cash flows from the project in d. are certain? (18 marks)

Answer rating: 100% (QA)

a An increase in borrowings of 100mn will result in a change in the companys rating from BBB to B le... View the full answer