Question: As CEO of a major corporation, you have to make a decision on how much you can afford to borrow. You currently have 10 million shares outstanding, and the market price per share is $50. You also currently have about $200 million in debt outstanding (market value). You are rated as a BBB corporation now.

(a) Your stock has a beta of 1.5 and the six-month T.Bill rate is 8%.

(b) Your marginal tax rate is 46%.

(c) You estimate that your rating will change to a B if you borrow $100 million. The BBB rate now is 11%. The B rate is 12.5%.

I. Given the marginal costs and benefits of borrowing the $100 million, should you go ahead with it ?

II. What is your best estimate of the weighted average cost of capital with and without the $100 million in borrowing ?

III. If you borrow the $100 million, what will the price per share be after the borrowing

IV. Assume that you have a project that requires an investment of $100 million. It has expected before-tax revenues of $50 million, and costs of $30 million a year in perpetuity. Is this a desirable project by your criteria? Why or Why not?

V. Does it make a difference in your decision if you were told that the cash flows from the project in (IV) are certain?