You are trying to figure out the optimal level of debt for Canadian Home Products...
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You are trying to figure out the optimal level of debt for Canadian Home Products (CHP) and are evaluating whether 0%, 13%, 24%, 35%, 51%, 64% debt ratio (as a % of market value) is most beneficial for this firm. Currently, the firm is unlevered and has a value of $7,500. The firm is in a 35% tax bracket and you expect that a firm is likely to lose 30% of firm value in bankruptcy. You have estimated the credit rating and the associated probability of default given each level of debt, as shown in the table below. (numbers mentioned in this question are in millions)
Using the information for CHP provided above, the perpetual tax benefit of debt at at 35% is $1,050 million (in other words $1.05 billion).
TRUE or FALSE
Using the information for CHP provided above and taking into account the benefits and costs of debt, the optimal level of debt for CHP is______.
Debt/Value (based on Market Value) Debt Credit Rating Probability of Default 13% 24% 35% 51% $ $ $ $ $ 1,000 AAA 2,000 A 3,000 BBB 4,000 B/CCC 5,000 CCC 0.10% 0.70% 3.40% 39.90% 53.00% 64%
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