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Santa Fe Pacific has a beta of 1.25 (estimated from a linear regression). It currently...

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Accounting

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%

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