Estimating the optimal Level of Leverage Complete the table by filling out the yellow cells. You may need to refer to worksheet "Bondrating Debt Cost" / Show your process or formulas used. Tax rate 40.00% Risk Free rate 5.00% Market premium 7.00% % in Debt % in Equity Bond rating Before tax After tax cost of debt cost of debt Beta Cost of equity (CAPM) WACC 1.2 0% 20% 40% 60% 80% A BBB BB D 12.00% 15.00% Noninvestment grade BB B Credit Rating Investment grade Key Industrial Financial Ratios (Three-year medians 2000-02) A4 A BBB EBIT interest coverage (x) 23.4 13.3 6.3 3.9 EBITDA interest coverage (x) 25.3 16.9 8.3 5.4 Funds from operations/total debt %) 214.2 65.7 42.2 30.6 Free operating cash flow/total debt (%) 156.6 33.6 22.3 12.8 Return on capital (%) 35.0 26.6 18.1 13.1 Operating income/sales (%) 23.4 24.0 18.1 15.5 Long-term debt capital (*) (1.1) 21.1 33.8 40.3 Total debt/capital, incl. short-term debt (%) 5.0 35.9 42.6 47.0 Standard & Poor's defined these ratios based on the book value of these items as follows: EBIT interest coverage - EBIT/interest expense. EBITDA interest coverage = (EBIT plus depreciation and amortization) /interest expense Long-term debt/capital = long-term debt/(long-term debt + stockholders' equity) Total debt capital, incl. short-term debt = (short-term debt + long-term debty(short-term debt + long-term debt + stockholders' equity) Source of data: Standard & Poor's CreditStats. 2.2 3.2 19.7 7.3 11.5 15.4 53.6 57.7 1.0 1.7 10.4 1.5 8.0 14.7 72.6 75.1 Capital Costs by Rating Category Investment grade Noninvestment grade AAA BBB BB B Cost of debt (pretax) 5.00% 6.00% 7.00% 8.00% 10.00% 11.00%