A Company is currently in the process of determining its optimal capital structure, which includes both debt and common stock. To assess the cost of debt, the company has compiled a table of relevant data. Percent financed with debt 0.1 0.2 0.3 0.4 0.5 Bond rating AA A A 88 B Before-tax cost of debt (%) 7 8 The company's tax rate is 40 percent. When estimating the cost of common equity, the company relies on the Capital Asset Pricing Model (CAPM). According to this model, the risk-free rate is 5 percent, and the market risk premium is 6 percent. It has been determined that if the company had no debt, its beta would be 1.0. The company is considering a new project that promises an Internal Rate of Return (IRR) of 10.5%. Evaluate whether the company should accept this project and recommend the optimum capital structure that would maximize return.
A Company is currently in the process of determining its optimal capital structure, which includes both debt and common stock. To assess the cost of debt, the company has compiled a table of relevant data. Percent financed with debt 0.1 0.2 0.3 0.4 0.5 Bond rating AA A A 88 B Before-tax cost of debt (%) 7 8 The company's tax rate is 40 percent. When estimating the cost of common equity, the company relies on the Capital Asset Pricing Model (CAPM). According to this model, the risk-free rate is 5 percent, and the market risk premium is 6 percent. It has been determined that if the company had no debt, its beta would be 1.0. The company is considering a new project that promises an Internal Rate of Return (IRR) of 10.5%. Evaluate whether the company should accept this project and recommend the optimum capital structure that would maximize return.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:A Company is currently in the process of determining its optimal capital structure, which includes
both debt and common stock. To assess the cost of debt, the company has compiled a table of
relevant data.
Percent financed with debt
0.1
0.2
0.3
0.4
0.5
Bond rating
AA
A
A
BB
B
Before-tax cost of debt (%)
7
7.2
8
8.8
9.6
The company's tax rate is 40 percent. When estimating the cost of common equity, the company
relies on the Capital Asset Pricing Model (CAPM). According to this model, the risk-free rate is 5
percent, and the market risk premium is 6 percent. It has been determined that if the company
had no debt, its beta would be 1.0.
The company is considering a new project that promises an Internal Rate of Return (IRR) of
10.5%. Evaluate whether the company should accept this project and recommend the optimum
capital structure that would maximize return.
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