Problem -
Firm has consulted with investment bankers and determined the interest rate it would pay for different capital structures, as shown below. Data for the risk-free rate, the market risk premium, an estimate of firm's unlevered beta, and the tax rate are also shown below. Based on this information, what is the firm's optimal capital structure and what is the weighted average cost of capital at the optimal structure?
|
Percent Financed with Debt (wd)
|
Before-tax Cost Debt (rd)
|
|
0%
|
6.0%
|
|
10%
|
6.1%
|
|
20%
|
7.0%
|
|
30%
|
8.0%
|
|
40%
|
10.0%
|
|
50%
|
12.5%
|
|
60%
|
15.5%
|
|
70%
|
18.0%
|
|
Input Data
|
|
|
Risk-free rate
|
4.5%
|
|
Market risk premium
|
5.5%
|
|
Unlevered beta
|
0.8
|
|
Tax rate
|
40.0%
|
Fill in formulas in the cells to find the optimum capital structure.
|
Debt/Value
|
Equity/Value
|
Debt/Equity
|
A-T Cost of
|
Levered
|
Cost of
|
|
|
Ratio (wd)
|
Ratio (ws)
|
Ratio (wd/ws)
|
Debt (rd)
|
Beta
|
Equity
|
WACC
|
|
0%
|
1.0
|
0.00
|
|
|
|
|
|
10%
|
0.9
|
0.11
|
|
|
|
|
|
20%
|
0.8
|
0.25
|
|
|
|
|
|
30%
|
0.7
|
0.43
|
|
|
|
|
|
40%
|
0.6
|
0.67
|
|
|
|
|
|
50%
|
0.5
|
1.00
|
|
|
|
|
|
60%
|
0.4
|
1.50
|
|
|
|
|
|
70%
|
0.3
|
2.33
|
|
|
|
|
Explain how the cost of debt AND the cost of stock are a function of the level of debt of a company.
Explain why shareholders benefit when WACC is minimized.
Discuss any other concerns managers might face when setting capital structure.
Attachment:- Assignment.rar