Aa Understanding the optimal capital structure Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio rd rs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? Debt ratio = 40%; equity ratio = 60% Debt ratio = 50%; equity ratio = 50% Debt ratio = 70%; equity ratio = 30% Debt ratio = 30%; equity ratio = 70% Debt ratio = 60%; equity ratio = 40% Consider this case:
Aa Understanding the optimal capital structure Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio rd rs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? Debt ratio = 40%; equity ratio = 60% Debt ratio = 50%; equity ratio = 50% Debt ratio = 70%; equity ratio = 30% Debt ratio = 30%; equity ratio = 70% Debt ratio = 60%; equity ratio = 40% Consider this case:
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
Related questions
Concept explainers
Dividend Policy
A dividend is a part of the profit paid to the shareholder in an organization. The management of the organization has the right to decide the policy for giving a dividend from the earnings to the shareholder. However, an organization is not in the obligation to declare a dividend for the investor. Dividend policy differs from organization to organization. As the management has the only authority to decide dividend rate, dividend amount, and time of dividend payout by considering all other elements that create an impact on the payment of a dividend.
Stocks And Dividends
Stock or equities are generally sold and bought in the Stock Exchange or which is popularly known as the stock market. Stocks are issued in the Stock Exchange for the sole purpose of raising funds for the Corporation or the company itself. Now since an individual has purchased a portion of the Corporation or company, he or she may claim to be a part of the earnings or profit of the company.
Question
Transcribed Image Text:**9. Determining the Optimal Capital Structure**
**Understanding the Optimal Capital Structure**
Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis.
**Table: Financial Data for Various Capital Structures**
| Debt Ratio | Equity Ratio | \( r_d \) | \( r_s \) | WACC |
|------------|--------------|---------|---------|------|
| 30% | 70% | 7.00% | 10.50% | 8.61% |
| 40% | 60% | 7.20% | 10.80% | 8.21% |
| 50% | 50% | 7.70% | 11.40% | 8.01% |
| 60% | 40% | 8.90% | 12.20% | 8.08% |
| 70% | 30% | 10.30% | 13.50% | 8.38% |
- **Debt Ratio**: Percentage of capital in debt
- **Equity Ratio**: Percentage of capital in equity
- \( r_d \): Cost of debt
- \( r_s \): Cost of equity
- **WACC**: Weighted average cost of capital
**Question:**
Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure?
- ○ Debt ratio = 40%; equity ratio = 60%
- ○ Debt ratio = 50%; equity ratio = 50%
- ○ Debt ratio = 70%; equity ratio = 30%
- ○ Debt ratio = 30%; equity ratio = 70%
- ○ Debt ratio = 60%; equity ratio = 40%
**Consider this Case:**
Globo-Chem Co. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 65% equity and 35% debt. The firm’s cost of debt will be 8%, and it will face a tax rate of 40%.
Transcribed Image Text:**Consider this case:**
---
**Globo-Chem Co.** is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 65% equity and 35% debt. The firm’s cost of debt will be 8%, and it will face a tax rate of 40%.
---
**What will Globo-Chem Co.’s beta be if it decides to make this change in its capital structure?** __________
---
**Now consider the case of another company:**
---
**U.S. Robotics Inc.** has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 8%, and its tax rate is 40%. It currently has a levered beta of 1.25. The risk-free rate is 3%, and the risk premium on the market is 7.5%.
---
U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm’s level of debt will cause its before-tax cost of debt to increase to 10%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm’s weighted average cost of capital (WACC) be if it makes this change in its capital structure? _________
---
**The optimal capital structure is the one that __________ the WACC and __________ the firm’s stock price. Higher debt levels __________ the firm’s risk. Consequently, higher levels of debt cause the firm’s cost of equity to __________.**
---
**Axis Chemical Co.** has found that its expected EPS is maximized at a debt ratio of 45%. Does this mean that Axis Chemical Co.’s optimal capital structure calls for 45% debt?
- Yes
- No
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
This is a popular solution!
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 2 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Recommended textbooks for you
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education