Question

yes to its optimal value is assumed, $1.25. Estimate has had a history ncial conservatism. In c. It is estimated that if Upjohn moves to its or debt ratio and no growth in firm value is a to the value per share will increase by $1.25. Est the cost of capital at the optimal debt ratio. 16. Nucor, an innovative steel company, has had a bi of technical innovation and financial conservat 1995, Nucor had only $210 million in debt outstand ing (book as well as market value) and $4.2 billion i market value of equity (with a book value of $123 billion). In the same year, Nucor had earnings before interest and taxes of $372 million and faced a corpo rate tax rate of 36%. The beta of the stock is 0.75, and the company is AAA rated (with a market interest rate of 6.80%). rebt. debt. Hiffer- t this anies acity. value and nar- ond MAA sury a. Estimate the return differential between return on equity and cost of equity at the current level of debt. b. Estimate the return differential at a debt ratio of 30%, assuming that the bond rating will drop to A-, leading to market interest rate of 8.00%. 17. Bethlehem Steel, one of the oldest and largest steel companies in the United States, is considering the question of whether it has any excess debt capacity. The firm has $527 million in market value of debt outstanding and $1.76 billion in market value of equity. The firm has earnings before interest and tax of $131 million and faces a corporate tax rate The company's bonds are rated BBB, and the co debt is 8%. At this rating, the firm has a probabiny default of 2.30%, and the cost of bankruptcy expected to be 30% of firm value. a. Estimate the unlevered value of the firm. Porate tax rate of 36%. ng if nds a probability of mate arm

Please walk me through how they got 6.5% for the equation. This problem uses the return differential method.

Answer 1

In this question, the Risk free rate is mentioned as 6.50%. If we look at question 19-15 which is just above, we can see that the treasury bond rate has been mentioned as 6.50%. The treasury bond is a proxy for the risk free rate and thus risk free rate has been taken as 6.50%