Question 5 Pennsylvania Steel, one of the largest steel companies in the united

Question

Question 5

Pennsylvania Steel, one of the largest steel companies in the united States, is considering whether it has any excess debt capacity. The company has $527 million in market value of debt outstanding and $1.76 billion of market value of equity. The company has EBIT of $131 million and faces a corporate tax rate of 36%. The company’s bonds are rated BBB, and the cost of debt is 8%. At this rating the company has a probability of default of 2.30%, and the cost of bankruptcy is estimated to be 30% of firm value.

Estimate the unlevered value of the firm.
Estimate the levered value of the firm using the APV approach, at a debt ratio of 50%. At that debt ratio, the firm’s bond rating will be CCC, and the probability of default will increase to 30%.

Explanation / Answer

EBIT = 131 m

Less:-Interest on Debt (527*8%) = 42.16

PBT = 88.84

Less:Tax @ 36% = 31.98

PAT = 56.86

..

Unlevered Value of the firm = PAT/Ke

= 56.86/Ke

Note :- cost of equity (KE) is not given in the question

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..

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Levered value of the firm = EBIT/WACC

= 131/WACC

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Note:-COst of Equity*50% + Cost of Debt*50%

= Ke*0.5 + (8*0.64)*o,5

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Note Cost of equity not given in the question

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Put th evalue of KE , you will get all the answers.

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