SantaFePacific
amajorrailoperatorwithdiversifiedoperationshadearningsbefore interesttaxesanddepreciationof$637millionin1993withdepreciationamountingto
$235
million (offsetbycapital expenditureof an equivalent amount).
The firmis in steadystateandexpectedtogrow6%ayearinperpetuity.SantaFePacifichadabetaof 1.25in1993anddebtoutstandingof$1.34billion.Thestockpricewas$18.25attheend of1993andtherewere183.1millionsharesoutstanding.Theexpectedratingsandthe
costsofdebtatdifferent
levelsofdebtforSantaFeareshowninthefollowing
table(The treasurybondrateis7%andthefirmfacedataxrateof40%.).D/(D+E)RatingCostofDebt(Pre-tax)0%AAA6.23%10%AAA6.23%20%A+6.93%30%A-7.43%40%BB8.43%50%B+8.93%60%B-10.93%70%CCC11.93%80%CCC11.93%90%CC13.43%Theearningsbeforeinterestandtaxesareexpectedtogrow3%ayearinperpetuity
with capitalexpendituresoffsetbydepreciation.(Thetaxrateis40%
the
treasurybondrate
is 7% and the market risk premium is 5.5%.)a. Estimate the cost of capital at the current debt ratio.b.Estimate the
costs of capital at debt ratios ranging from 0% to 90%. c. Estimate the
value of the
firm at debt
ratios ranging from
0% to 90%.