Aa

4.05% (Eu)51

1.00%

5.05%

38%

3.13%

Aracruz52

B+

4% ($)

3.25%

7.25%

34%

4.79%

51 The default spreads for bonds issued by banks can be very different from the spreads for industrial companies. The default spread for an AA- rated financial service company was much higher at the time of this analysis than the default spread for an AA- rated manufacturing company.

52 With Araacruz, one troublesome aspect of the pre-tax cost of debt is that it is lower than the rate at which the Brazilian government can borrow. While there are some cases where we would add the default spread of the country to that of the firm to get to a pre-tax cost of debt, Aracruz may be in a stronger position to borrow in U.S. dollars than the Brazilian government because it sells its products in a global market and gets paid in dollars.

The marginal tax rates of the US (Disney), Brazil (Aracruz) and Germany (Deutsche Bank) are used to compute the after-tax cost of debt. We will assume that all of Disney's divisions have the same cost of debt and marginal tax rate as the parent company.

• Synthetic Ratings: For Bookscape, there are no recent borrowings on the books, thus making the synthetic rating for the firm our only choice. In 2003, Bookscape had no interest expenses and reported operating income of $ 2 million after operating lease expenses of $ 600,000. If we consider the current year's operating operating lease expenses to be the equivalent of interest expenses, the resulting interest coverage ratio is 4.33, yielding a synthetic rating of A- for the firm.53 Adding the default spread of 1.5% associated with that rating to the riskfree rate results in a pre-tax cost of debt for 5.50%. The after-tax cost of debt is computed using a 40% marginal tax rate:

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