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Cost of Debt

Synthetic rating
EBIT 2007 50
Interest exp 15
EBIT/Int exp 3.3x

High Market Cap firms Low Market Cap Firms

Interest Coverage Interest Coverage
Ratio Rating Spread Ratio Rating
> 8.5 AAA 0.75% > 12.50 AAA
6.50 -8.50 AA 1.00% 9.50 - 12.50 AA
5.50 - 6.50 A+ 1.50% 7.50 - 9.50 A+
4.25 - 5.50 A 1.80% 6.00 - 7.50 A
3.00 - 4.25 A- 2.00% 4.50 - 6.00 A-
2.50 -3.00 BBB 2.25% 3.50 - 4.50 BBB
2.00 - 2.50 BB 3.50% 3.00 - 3.50 BB
1.75 - 2.00 B+ 4.75% 2.50 - 3.00 B+
1.50 - 1.75 B 6.50% 2.00 - 2.50 B
1.25 - 1.50 B- 8.00% 1.50 - 2.00 B-
0.80 - 1.25 CCC 10.00% 1.25 - 1.50 CCC
0.65 - 0.80 CC 11.50% 0.80 - 1.25 CC
0.20 - 0.65 C 12.70% 0.50 - 0.80 C
< 0.20 D 14.00% < 0.50 D

Default Spread 3.50%

Risk Free Rate 5.00%
Cost of Debt 8.50%
After tax cost of debt 5.70%

Cost of Equity

D/E Effective
Company Levered Beta Unlevered beta
Ratio tax rate %

Comp 1 1.14 0.40 30.7% 0.89

Comp 2 0.98 1.30 30.0% 0.51
Comp 3 1.18 1.87 32.0% 0.52
Comp 4 0.85 0.99 22.7% 0.48
Comp 5 1.31 0.67 10.3% 0.82
Comp 6 1.25 1.35 9.6% 0.56
Comp 7 0.78 1.03 10.8% 0.41
Comp 8 1.09 0.97 18.0% 0.61
Mean 1.07 1.07 0.21 0.60
Median 1.12 1.01 0.20 0.54

Beta of ABC company WACC of ABC company

Unlevered Beta 0.60 Risk Free rate 4.50%
Debt/Equity 0.48 Market risk premium 5.00%
Tax rate 33.0% Levered beta of ABC 0.79
Levered beta of ABC 0.79 Cost of equity 8.47%
Pre-tax cost of debt 8.50%
Tax rate 33.00%
After tax cost of debt 5.70%
WACC 7.57%

Debt/ Debt + Equity 0.33

Equity/ Debt + Equity 0.67

Scenario Analysis

Equity beta at various unlevered beta and capital structure

Unlevered Beta
0.79 0.40 0.50 0.60
0.4 0.51 0.63 0.76
Debt to Equity

0.6 0.56 0.70 0.84

0.8 0.61 0.77 0.92
1 0.67 0.84 1.00
1.2 0.72 0.90 1.08

WACC at various unlevered beta and capital structure

Unlevered Beta
0.08 0.40 0.50 0.60
0.4 6.60% 7.03% 7.45%
Debt to Equity

0.6 6.78% 7.25% 7.72%

0.8 6.96% 7.48% 8.00%
1 7.14% 7.70% 8.27%
1.2 7.32% 7.93% 8.54%
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Spread
0.75%
1.00%
1.50%
1.80%
2.00%
2.25%
3.50%
4.75%
6.50%
8.00%
10.00%
11.50%
12.70%
14.00%
Beta
0.70 0.80
0.89 1.01
0.98 1.12
1.08 1.23
1.17 1.34
1.26 1.44

Beta
0.70 0.80
7.88% 8.31%
8.20% 8.67%
8.51% 9.03%
8.83% 9.39%
9.15% 9.75%