You have been provided the information on the cost of debt and cost of capital t
ID: 2638651 • Letter: Y
Question
You have been provided the information on the cost of debt and cost of capital that a company will have at a 10% debt ratio, and asked to estimate the UNLEVERED BETA. The long term treasury bond rate is 6%. Assume the market risk premium is 6.9%.
Debt Ratio
10%
24%
$ Debt
$ 1,500
EBIT
$ 1,000
Interest Expenses
$120
Interest Coverage Ratio
5.13
Bond Rating
A
Interest Rate
5%
Tax Rate
40%
Beta
1.42
The interest coverage ratios, ratings and spreads are as follows:
Coverage Ratio
Rating
Spread over Treasury
> 10
AAA
0.30%
7 -10
AA
1.00%
5 - 7
A
1.50%
3 - 5
BBB
2.00%
2- 3
BB
2.50%
1.25 - 2
B
3.00%
0.75 - 1.25
CCC
5.00%
0.50 - 0.75
CC
6.50%
0.25 - 0.50
C
8.00%
< 0.25
D
10.00%
Debt Ratio
10%
24%
$ Debt
$ 1,500
EBIT
$ 1,000
Interest Expenses
$120
Interest Coverage Ratio
5.13
Bond Rating
A
Interest Rate
5%
Tax Rate
40%
Beta
1.42
Explanation / Answer
Answer:
Calculation showing unlevered Beta:
Debt Ratio
10%
24%
$ Debt
$ 1,500
$3,600
EBIT
$ 1,000
$ 2,400
Interest Expenses
$120
$ 288
Interest Coverage Ratio
5.13
5.13
Bond Rating
A
A
Interest Rate
5%
5%
Tax Rate
40%
40%
Beta
1.42
3.40
Therefore, Unlevered Beta Is 3.40
Debt Ratio
10%
24%
$ Debt
$ 1,500
$3,600
EBIT
$ 1,000
$ 2,400
Interest Expenses
$120
$ 288
Interest Coverage Ratio
5.13
5.13
Bond Rating
A
A
Interest Rate
5%
5%
Tax Rate
40%
40%
Beta
1.42
3.40
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