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Octane Music currently has $40 million of debt at 9 percent interest rate. Its stock price...

Octane Music currently has $40 million of debt at 9 percent interest rate. Its stock price is $40 per share with 4 million shares outstanding. Octane is a zero-growth firm. The company's EBIT is $29.866 million, tax rate is 40 percent, market risk premium is 5 percent, risk free interest rate is 6 percent. Octane is considering increasing its debt ratio to 40 percent (based on market values) and buying back some shares with the extra borrowed funds. Interest rate on the new debt will be 10 percent. Octane's beta is currently 2.0. Calculate Octane's unlevered beta (please use market value debt-to-equity ratio)

Calculate Octane's new beta (levered beta) with 40 percent debt ratio

A. 0.87

B. 1.21

C. 1.60

D. 2.24

E. None of the above

Expert Solution

Current value of debt = $40 million

Current value of equity = $40 x 4 million = $160 million

Current debt to equity ratio = $40 million / $160 million = 1 / 4

or,

Now, new debt ratio = 40% or 40 / 100 or 2 / 5

The unlevered beta remains the same irrespective of capital structure changes. Now, we input the values in the above formula and compute new levered beta -

or,

or, (None of the above)

jeff jeffy answered 1 year ago

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