Question

12.4 The Debt Cost of Capital

 

Use the following information to answer the question(s) below.

 

Consider the following information regarding corporate bonds:

 

Rating	AAA	AA	A	BBB	BB	B	CCC
Average Default Rate	0.0%	0.0%	0.2%	0.4%	2.1%	5.2%	9.9%
Recession Default Rate	0.0%	1.0%	3.0%	3.0%	8.0%	16.0%	43.0%
Average Beta	0.05	0.05	0.05	1.0	0.17	0.26	0.31

 

1) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The corresponding risk-free rate is 3% and the market risk premium is 5%. Assuming a normal economy, the expected return on Wyatt Oil’s debt is closest to:

A) 3.0%

B) 3.5%

C) 4.9%

D) 5.5%

 

2) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The bondholders expected loss rate in the event of default is 70%. Assuming a normal economy the expected return on Wyatt Oil’s debt is closest to:

A) 3.0%

B) 3.5%

C) 4.9%

D) 6.7%

 

 

3) Wyatt Oil has a bond issue outstanding with seven years to maturity, a yield to maturity of 7.0%, and a BBB rating. The bondholders expected loss rate in the event of default is 70%. Assuming the economy is in recession, then the expected return on Wyatt Oil’s debt is closest to:

A) 3.5%

B) 4.9%

C) 5.5%

D) 7.0%

 

 

4) Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating. The corresponding risk-free rate is 3% and the market risk premium is 6%. Assuming a normal economy, the expected return on Rearden Metal’s debt is closest to:

A) 0.6%

B) 1.6%

C) 4.6%

D) 6.0%

 

 

5) Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating. The bondholders expected loss rate in the event of default is 50%. Assuming a normal economy the expected return on Rearden Metal’s debt is closest to:

A) 0.6%

B) 1.6%

C) 4.6%

D) 6.0%

 

 

6) Rearden Metal has a bond issue outstanding with ten years to maturity, a yield to maturity of 8.6%, and a B rating. The bondholders expected loss rate in the event of default is 50%. Assuming the economy is in recession, then the expected return on Rearden Metal’s debt is closest to:

A) 0.6%

B) 1.6%

C) 4.6%

D) 6.0%

 

 

7) Nielson Motors plans to issue 10-year bonds that it believes will have an BBB rating. Suppose AAA bonds with the same maturity have a 3.5% yield. Assume that the market risk premium is 5% and the expected loss rate in the event of default on the bonds is 60%. The yield that these bonds will have to pay during average economic times is closest to:

A) 3.50%

B) 3.75%

C) 4.00%

D) 5.50%

 

8) Nielson Motors plans to issue 10-year bonds that it believes will have an BBB rating. Suppose AAA bonds with the same maturity have a 3.5% yield. Assume that the market risk premium is 5% and the expected loss rate in the event of default on the bonds is 60%. The yield that these bonds will have to pay during a recession is closest to:

A) 3.50%

B) 3.75%

C) 4.00%

D) 5.50%

 

 

12.5 A Project’s Cost of Capital

 

Use the following information to answer the question(s) below.

 

Consider the following information regarding corporate bonds:

 

Rating	AAA	AA	A	BBB	BB	B	CCC
Average Default Rate	0.0%	0.0%	0.2%	0.4%	2.1%	5.2%	9.9%
Recession Default Rate	0.0%	1.0%	3.0%	3.0%	8.0%	16.0%	43.0%
Average Beta	0.05	0.05	0.05	1.0	0.17	0.26	0.31

 

Company	Market  Capitalization ($mm)	Total  Enterprise Value ($mm)	Equity  Beta	Debt  Rating
Taggart Transcontinental	$4,500	8,000	1.1	BBB
Rearden Metal	$3,800	7,200	1.3	AAA
Wyatt Oil	$2,400	3,800	0.9	A
Nielson Motors	$1,500	4,400	1.75	BB

 

1) Your estimate of the debt beta for Taggart Transcontinental would be:

A) 0.05

B) 0.10

C) 0.17

D) 1.00

 

 

2) Your estimate of the debt beta for Nielson Motors would be:

A) 0.10

B) 0.17

C) 1.00

D) 1.68

 

3) Your estimate of the asset beta for Taggart Transcontinental is closest to:

A) 0.42

B) 0.59

C) 0.66

D) 0.71

 

 

4) Your estimate of the asset beta for Rearden Metal is closest to:

A) 0.42

B) 0.59

C) 0.66

D) 0.71

 

 

5) Your estimate of the asset beta for Wyatt Oil is closest to:

A) 0.59

B) 0.66

C) 0.71

D) 0.90

 

 

 

6) Your estimate of the asset beta for Nielson Motors is closest to:

A) 0.59

B) 0.66

C) 0.71

D) 1.75

 

 

7) Suppose that because of the large need for steel in building railroad infrastructure, Taggart Transcontinental and Rearden Metal decide to into one large conglomerate. Your estimate of the asset beta for this new conglomerate is closest to:

A) 0.42

B) 0.59

C) 0.66

D) 0.68

 

 

Use the following information to answer the question(s) below.

 

Consider the following information regarding corporate bonds:

 

Rating	AAA	AA	A	BBB	BB	B	CCC
Average Default Rate	0.0%	0.0%	0.2%	0.4%	2.1%	5.2%	9.9%
Recession Default Rate	0.0%	1.0%	3.0%	3.0%	8.0%	16.0%	43.0%
Average Beta	0.05	0.05	0.05	1.0	0.17	0.26	0.31

 

8) Galt Industries has a market capitalization of $50 billion, $30 billion in BBB rated debt, and $8 billion in cash. If Galt’s equity beta is 1.15, then Galt’s underlying asset beta is closest to:

A) 0.84

B) 0.92

C) 1.00

D) 1.15

 

9) Trucks R’ Us has a market capitalization of $142 billion, $78 billion in BB rated debt, and $10 billion in cash. If Trucks R’ Us’ equity beta is 1.68, then their underlying asset beta is closest to:

A) 1.00

B) 1.20

C) 1.32

D) 1.48

 

10) Luther Industries has a market capitalization of $23 billion, no debt, and $4 billion in cash. If Luther’s estimated equity beta is 1.32, then the beta of Luther’s underlying business enterprise is closest to:

A) 1.09

B) 1.32

C) 1.48

D) 1.60