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Chapter 9 Question 7
7. You are attempting to structure a debt issue for Eaton Corporation, a manufacturer of automotive components, You have collected the following information on the market values of debt and equity for the past 10 years

Year Market Value of Equity

(in millions) ($)


(in millions) ($)

1985 1,824.9 436
1986 2,260.6 632
1987 2,389.6 795
1988 1,960.8 655
1989 2,226 836
1990 1,875.9 755
1991 2,009.7 795
1992 2,589.3 833
1993 3,210 649
1994 3,962.7 1053


In addition, you have the following information on the changes in long-term interest rates, inflation rates, gross national product (GNP), and exchange rates over the same period.



Year Long Bond 

Rate (%)


Growth (%)




Rate (%)

1985 11.40 6.44 125.95 3.50
1986 9.00 5.40 112.89 1.90
1987 9.00 5.40 112.89 1.90
1988 9.70 7.89 95.32 4.10
1989 9.30 5.35 96.25 5.40
1990 9.30 5.35 96.25 5.40
1991 8.80 2.88 98.82 4.20
1992 8.10 6.22 104.58 3.00
1993 7.20 5.34 105.22 3.00
194 8.00 5.97 98.60 2.60


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Using this information,

a. Estimate the duration of this firm’s projects. How would you use this information in designing the debt issue?
b. How cyclical is this company? How would that affect your debt issue?

c. Estimate the sensitivity of firm value to exchange rates. How would you use this information in debt signing the deb issue?
d. How sensitive is firm value to inflation rates? How would you use this information in designing the debt issue?
e. What factors might lead you to override the results of this analysis?

Chapter 9 Question 10


Pfizer, a major pharmaceutical company, has a debt ratio of 10.30% and is considering increasing its debt ratio to 30%. Its cost of capital is expected to drop from 14.51% to 13.45%. Pfier had an EBIT of $2 million in 1995 and a book value of capital (deb + equity) of approximately $8 billion. It also faced a tax rate of 40% on its income. The stock in the firm is widely held, but the corporate charter includes significant antitakeover restrictions.

a. Should Pfizer move to its desired debt ratio quickly or gradually? Explain.
b. Given the choice in part a, explain how you would move to the optimal?

c. Pfizer considers using the excess debt capacity for an acquisition. What are some of the concerns it should have?

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