Assume that your company is trying to determine its optimal capital structure, which consists only of debt and common stock. To estimate the cost of debt, the company has produced the following table: 9.86% 9.56% Percent Financed Percent Financed With Debt With Equity 10.16% O 8.96% 9.26% 0.10 0.20 0.30 0.40 0.50 0.90 0.80 0.70 0.60 0.50 Debt/Equity Ratio 0.10/0.900.11 0,20/0.80 0.25 0.30/0.70 = 0.43 0.40/0.600.67 0.50/0.50 = 1.00 Now assume that the company's tax rate is 40 percent, that the company uses the CAPM to estimate its cost of common equity, Ks, that the risk-free rate is 5 percent and the market risk premium is 6 percent. Finally assume that if it has no debt its WACC would be equal to its cost of equity which would be equal to 11 percent (you should now be able to determine its "unlevered beta," bu). Bond Rating AA A A Given this information, determine the firm's cost of capital if it finances with 40 percent debt and 60 percent equity. BB B Before-Tax Cost of Debt 7.0% 7.2% 8.0% 8.8% 9.6%

Assume that your company is trying to determine its optimal capital structure, which consists only of debt and common stock. To estimate the cost of debt, the company has produced the following table: 9.86% 9.56% Percent Financed Percent Financed With Debt With Equity 10.16% O 8.96% 9.26% 0.10 0.20 0.30 0.40 0.50 0.90 0.80 0.70 0.60 0.50 Debt/Equity Ratio 0.10/0.900.11 0,20/0.80 0.25 0.30/0.70 = 0.43 0.40/0.600.67 0.50/0.50 = 1.00 Now assume that the company's tax rate is 40 percent, that the company uses the CAPM to estimate its cost of common equity, Ks, that the risk-free rate is 5 percent and the market risk premium is 6 percent. Finally assume that if it has no debt its WACC would be equal to its cost of equity which would be equal to 11 percent (you should now be able to determine its "unlevered beta," bu). Bond Rating AA A A Given this information, determine the firm's cost of capital if it finances with 40 percent debt and 60 percent equity. BB B Before-Tax Cost of Debt 7.0% 7.2% 8.0% 8.8% 9.6%

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

See similar textbooks

Similar questions

Use the information in the following table to make a suggestion concerning the proportion of debt that the firm should utilize in its capital structure. Benefit or (cost) No debt 25% debt 50% debt Tax shield $0 $15 $25 75% debt $35 Agency cost -$10 -$4 -$4 -$16 Financial distress cost -$3 -$2 -$8 -$19 The firm can maximize firm value by choosing (25%, 50%, 75% or 0%) debt capital structure.
A firm's capital is composed of the following sources and proportions: Source of Capital Weights Cost Long-term Debt 25% 6.0% Preferred Stock 35% 7.0% Common Stock 40% 8.0% The weighted average cost of capital is: A. 7.15%B. 6.85%C. 5.25%D. 7.00%
Richmond Clinic has obtained the following estimates for its costs of debt and equity at various capital structures: After-Tax Percent Cost of Cost of Debt Debt Equity 0% 16% 20% 6.6% 17% 40% 7.8% 19% 60% 10.2% 22% 80% 14.0% 27% What is the firms optimal capital structure? Please provide your answers in the following format: xx% Note: no decimals required. What percent equity? 15% What percent debt? 40%
explain the following: Weighted Average Cost of Capital (WACC): formula and what it measures Cost of Debt: formula and what it measures Assume a company has 10 million of total assets:
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 rdrd rsrs 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 = 70%; equity ratio = 30% Debt ratio = 50%; equity ratio = 50% Debt ratio = 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60% Debt ratio = 30%; equity ratio = 70% Consider this case: Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 70% equity and 30% debt. The firm’s cost of debt will be 10%, and it will face a tax rate of 40%. What will Globex…
Review this situation: Transworld Consortium Corp. is trying to identify its optimal capital structure. Transworld Consortium Corp. has gathered following financial information to help with the analysis. Debt Ratio 30% 40% 50% 60% 70% Equity Ratio 70% 60% 50% 40% 30% WACC 9.71% 9.55% 10.02% 7.55% 11.30% 10.78% 8.24% 12.80% 11.45% rd Is 6.02% 9.40% 6.75% 9.750% 7.15% 10.60% Which capital structure shown in the preceding table is Transworld Consortium Corp.'s optimal capital structure? Debt ratio= 30%; equity ratio = 70% Debt ratio = Debt ratio = 70%; equity ratio = 30% Debt ratio= 50%; equity ratio = 50% 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60%
1. The basic WACC equation The calculation of WACC involves calculating the weighted average of the required rates of return on debt, preferred stock, and common equity, where the weights equal the percentage of each type of financing in the firm's overall capital structure. is the symbol that represents the cost of preferred stock in the weighted average cost of capital (WACC) equation. Bryant Co. has $2.7 million of debt, $2.5 million of preferred stock, and $3.3 million of common equity. What would be its weight on common equity? O 0.23 O 0.32 O 0.26 O 0.39
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 rdrd rsrs 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% Consider this case: Globex Corp. currently has a capital structure consisting of 35% debt and 65% equity. However, Globex Corp.’s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3%, the market risk premium is 7%, and Globex Corp.’s beta is 1.10. If the firm’s tax rate is 25%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%,…
Assume a capital structure where stock is 50% and costs 14%, bonds are 40% and cost 8% and preferred is 10% and costs 11% what is the weighted average cost of capital when taxes are 25%___________?
The target capital structure is said to be constant with: Maximum Earnings Per Share (EPS) O Minimum Cost of Debt Minimum Cost of Equity O Minimum Weighted Average Cost of Capital (WACC) MM Proposition O Minimum Risk
The financial manager of a firm determines the following schedules of cost of debt and cost of equity for various combinations of debt financing: Debt/Assets After-Tax Cost of Debt Cost of Equity 0 % 4 % 7 % 10 4 7 20 4 7 30 4 9 40 5 10 50 5 12 60 8 13 70 8 15 Find the optimal capital structure (that is, optimal combination of debt and equity financing). Round your answers for the capital structure to the nearest whole number and for the cost of capital to one decimal place. The optimal capital structure: % debt and % equity with a cost of capital of % Why does the cost of capital initially decline as the firm substitutes debt for equity financing? The cost of capital initially declines because the firm cost of debt is than the cost of equity. Why will the cost of funds eventually rise as the firm becomes more financially leveraged? As the firm becomes more financially leveraged and riskier, the cost of debt…
3

SEE MORE QUESTIONS

Recommended textbooks for you

Essentials Of Investments

Finance

ISBN:

9781260013924

Author:

Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:

Mcgraw-hill Education,

FUNDAMENTALS OF CORPORATE FINANCE

Finance

ISBN:

9781260013962

Author:

BREALEY

Publisher:

RENT MCG

Financial Management: Theory & Practice

Finance

ISBN:

9781337909730

Author:

Brigham

Publisher:

Cengage

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

Essentials Of Investments

Finance

ISBN:

9781260013924

Author:

Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:

Mcgraw-hill Education,

FUNDAMENTALS OF CORPORATE FINANCE

Finance

ISBN:

9781260013962

Author:

BREALEY

Publisher:

RENT MCG

Financial Management: Theory & Practice

Finance

ISBN:

9781337909730

Author:

Brigham

Publisher:

Cengage

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

SEE MORE TEXTBOOKS