What Is the Maximum Rate That Can Be Paid on Debt

question 39

Multiple Choice

What is the maximum rate that can be paid on debt and maintain a 14% WACC with a 19% expected return on equity in a firm with a 60% debt-to-asset ratio? Ignore taxes.

• A)6.50%
• B)9.90%
• C)10.67%
• D)11.14% WACC = r_debt + r_equity
• 14% = r_debt(.60) + 19%(.40)
• 14% = .6r_debt + 7.6%

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Definitions:

Maturity Risk

The risk associated with the changing value of securities due to the time remaining until their maturity date.

Yield to Maturity

The total return anticipated on a bond if it is held until the maturity date, factoring in the current price, par value, coupon yield, and time to maturity.

Coupon Rate

Each year, the interest rate a bond yields, expressed in terms of the percentage of its face value.

Premium

A premium is the amount by which the price of a security or financial instrument exceeds its intrinsic or face value.