beforeinterestandtaxes.Toillustratethispoint,notethatthe
earnings beforeinterest and taxesat Titan Cement is 232
millioneuros.Aslongasinterestexpensesarelessthan 232
millioneuros,interest expensesremain fullytaxdeductible
andearnthe25.47%taxbenefit.Forinstance,ata70%debt
ratio,theinterestexpensesare 225 millioneurosandthetax
benefitistherefore25.47%ofthisamount.Atan80%debt
ratio,however,theinterestexpensesballoonto 295 million
euros,whichisgreaterthantheearningsbeforeinterestand
taxesof 232 millioneuros.Weconsiderthetaxbenefitonthe
interest expenses up to this amount.
Asaproportionofthetotalinterestexpenses,thetaxbenefit
is now less than 25.47%.
This, in turn, raises the after-tax cost of debt. This is a
conservativeapproach,sincelossescanbecarried forward.
Giventhatthisisapermanentshiftinleverage,itdoesmake
sense to be conservative.
Nowthatwehaveestimatedthecostofequityandthecostof
debt at each debt level, we can compute Titan’s cost of
capital.Thisisdoneforeachdebtlevelinthefollowingtable.
The cost of capital, which is 6.99% when the firm is
unlevered,decreasesasthefirminitiallyaddsdebt,reachesa
minimumof6.65%at40%debt,andthenstartstoincrease
again. (Firm value is in millions of euros.)