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 estima…
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