Question: Santa Fe Pacific has a beta of 1.25 (estimated from a linear regression). It currently has debt outstanding of $1.34 billion. Its stock price is $18.25 and there are 183.1 million shares outstanding. The expected ratings and the costs of debt for Santa Fe Pacific at different debt levels are shown in the following table:
|
D/(D+E)
|
Rating
|
Cost of debt (pretax)
|
|
10%
|
AAA
|
6.23%
|
|
30%
|
A-
|
7.43%
|
|
60%
|
B-
|
10.93%
|
|
80%
|
CCC
|
11.93%
|
|
90%
|
CC
|
13.43%
|
Estimate what the cost of capital would be at a debt to value ratio of 80%. Assume a tax rate of 40%, a T-bond rate of 7%, and market risk premium of 5.5%.