You are trying to estimate the value of Pear Corporation using the WACC approach. As a first step, you decided to estimate the companyâs cost of debt. While the companyâs current D/V is 0.20, you noticed that the company is expected to approximately double its D/V ratio next quarter. Therefore, you decided to work with a target D/V ratio equal to 0.40. You also noticed that the current rating of the companyâs debt is A and that this rating is expected to be downgraded to BBB- as a consequence of the expected increase in leverage. Therefore, you expect the company to have a BBB- rating from next quarter on. This motivated the collection of the information below.
U. S. Government Debt Treasuries)
Maturity
1 Year 30 Years
Historical Average Yield 2.70 4.30
Current Yield 0.55 3.10
Corporate Debt (A- Rating)
Maturity
1 Year 1 30 Years
Historical Average Spread 1.20 2 .10
Current Spread 0. 901 .30
Corporate Debt (BBB- Rating)
Maturity
1 Year 30 Years
Historical Average Spread 1.50 2.50
Current Spread 1.10 1.60
Note: All numbers above are in percentage points. The spread for the corporate debt is computed as the difference between the yields and the risk-free cate of same matuity.
Required:
1. Estimate the cost of debt for Pear Corporation. (Think: historical spread vs. current spread; Maturity of 1 year vs. Maturity of 30 years; A-rating vs. BBB-rating).
(a) 5.60%
(b) 3.10%
(c) 4.60%
(d) 4.70%
(e) 1.60%