2. Before we calculate the discount rate, we need to make the following assumptions:
a. Since Ms. Zhang wanted to keep things simple by assuming a stock purchase using the maximum amount of leverage available and a debt to value ratio not exceeding 50%, so we calculate the initial D/E=100% which is the maximum leverage for AirThread under this scenario.
b. AirThread neither rebalanced its capital structure during 2008 and 2012, nor did it keep its debt at a fixed level. It repays its debt monthly. However, the amount of debt repaid before the end of 2012 is small compared with the total amount of debt and the total bullet payment. So when we calculate debt cost of capital from 2008 to 2012, we assume that the debt maintains at a fixed amount till the end of 2012 and the periodic payments will not have effect on the debt cost of capital.
In order to use APV method to value the company from 2008 to 2012, we need to figure out the unlevered cost of asset-R(U) and cost of debt at initialization-R(D08-12) to discount the FCF back to 2007. According to Rubinstein & Ross the interest rate of the bond should be 5.5% at the initial leverage, so RD08-12=5.5%. And we expect to use the