capital structure.xlsxRTN_OCSRTN optimal cost structureRTN Optimal Cost Structure EstimationDebt:equityCurrent20:80 0:100 ...
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RTN Optimal Capital Structure

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RTN Optimal Capital Structure

  1. 1. capital structure.xlsxRTN_OCSRTN optimal cost structureRTN Optimal Cost Structure EstimationDebt:equityCurrent20:80 0:100 10:90 20:80 30:70 40:60 50:50 60:40 70:30 80:20 90:10 100:0[Cost of debt]S&P rating A AAA AA A BAA BA B CAA CAA CAA CAA CAACost of debt a 6.7% 6.5% 6.7% 7.3% 9.9% 11.9% 15.3% 15.3% 15.3% 15.3% 15.3%Risk free rate 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%Yield spread 0.9% 0.7% 0.9% 1.5% 4.1% 6.1% 9.6% 9.6% 9.6% 9.6% 9.6%Other factor 1.3% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3% 1.3%Effective tax rate (past 5 years) b 29.6% 29.6% 29.6% 29.6% 29.6% 29.6% 29.6% 29.6% 29.6% 29.6% 29.6%Cost of debt after tax c=a*(1-b) 4.7% 4.6% 4.7% 5.1% 7.0% 8.4% 10.8% 10.8% 10.8% 10.8% 10.8%[Cost of capital (CAPM)]Risk free rate d 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%Market premium e 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%Unlevered beta f 0.96 0.96 0.96 0.96 0.96 0.96 0.96 0.96 0.96 0.96 0.96Levered beta g* 1.07 0.96 1.04 1.13 1.25 1.41 1.64 1.97 2.54 3.66 7.04Cost of capital h=d+e*g 9.9% 9.3% 9.7% 10.1% 10.7% 11.6% 12.7% 14.4% 17.2% 22.8% 39.7%WACC i 8.8% 9.3% 9.2% 9.1% 9.1% 9.7% 10.5% 12.2% 12.7% 13.2% 13.7% 10.8%[Corporate value]Debt j=l*n 4,731 0 2,254 4,561 6,845 8,507 9,818 10,141 11,378 12,523 13,587 19,142Equity (market value) k=l*o 18,708 22,214 20,288 18,244 15,971 12,761 9,818 6,761 4,876 3,131 1,510 0Corporate value l*=m/i 23,439 22,214 22,542 22,805 22,815 21,268 19,635 16,902 16,254 15,654 15,097 19,142Implied FCF m* 2,066 2,066 2,066 2,066 2,066 2,066 2,066 2,066 2,066 2,066 2,066 2,066[Ratios]D/E ratio n 25.3% 0.0% 11.1% 25.0% 42.9% 66.7% 100.0% 150.0% 233.3% 400.0% 900.0%D/A ratio o 20.2% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0% 90.0% 100.0%E/A ratio p 79.8% 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0%Current S&P rating: the rating as at Dec 31, 2011(latest available)Implied S&P rating: the rating is up or down graded with a 10% change in D/A ratio based on the current rating and D/A ratio. (from AAA- to CAA)g*: calculated levered betas by hamada equation (Levered beta=unlevered beta*[1+(1-t)*D/E])m*: To simplify the estimation, we suppose that the FCF based on the current corporate value ("implied FCF") will continue forever (zero-growth model).Hence, the implied FCF is calculated based on the current corporate value divided by the current WACC.Cost of debt assumptionYield spreads over 10 year treasury bonds by bond ratings (basis points)AAA AA A BAA BA B CAAYield spread 58 71 92 147 410 610 955l*: the current corporate value is calculated based on indirect approach (debt value+equity value=corporate value) as direct approach, which calculates the corporate value directly based onFCF and WACC, highly relies on the terminal value calculation model (zero-base model, growth model etc.)Source: Graham R & Smart (2011). Introduction to Corporate Finance. Cengage LearningTable 4-3. The Relationship Between Bond Ratings and Spreads at 10 year Maturity in Basis

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