F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but it would like to add some debt to take advantage of the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: Market Equity-to- Before-Tax Cost of Debt (ra) Market Debt-to- Value Ratio (Wd) 0.0 Value Ratio (Ws) 1.0 Market Debt-to Equity Ratio (D/S) 0.00 0.10 0.90 0.1111 0.20 0.80 0.2500 0.70 0.60 0.4286 0.6667 0.30 0.40 6.0% 6.4 7.0 8.2 10.0 F. Pierce uses the CAPM to estimate its cost of common equity, rs, and at the time of the analaysis the risk-free rate is 6%, the market risk premium is 8%, and the company's tax rate is 25%. F. Pierce estimates that its beta now (which is "unlevered" because it currently has no debt) is 0.7. Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure? Do not round intermediate calculations. Round your answers to two decimal places. Debt: % Equity: % WACC: %
F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but it would like to add some debt to take advantage of the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: Market Equity-to- Before-Tax Cost of Debt (ra) Market Debt-to- Value Ratio (Wd) 0.0 Value Ratio (Ws) 1.0 Market Debt-to Equity Ratio (D/S) 0.00 0.10 0.90 0.1111 0.20 0.80 0.2500 0.70 0.60 0.4286 0.6667 0.30 0.40 6.0% 6.4 7.0 8.2 10.0 F. Pierce uses the CAPM to estimate its cost of common equity, rs, and at the time of the analaysis the risk-free rate is 6%, the market risk premium is 8%, and the company's tax rate is 25%. F. Pierce estimates that its beta now (which is "unlevered" because it currently has no debt) is 0.7. Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure? Do not round intermediate calculations. Round your answers to two decimal places. Debt: % Equity: % WACC: %
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:F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but it would like to add some debt to take advantage of the tax shield. Its investment banker has
indicated that the pre-tax cost of debt under various possible capital structures would be as follows:
Market Equity-to-
Before-Tax Cost of
Debt (ra)
Market Debt-to-
Value Ratio (Wd)
0.0
Value Ratio (Ws)
1.0
Market Debt-to
Equity Ratio (D/S)
0.00
0.10
0.90
0.1111
0.20
0.80
0.2500
0.70
0.60
0.4286
0.6667
0.30
0.40
6.0%
6.4
7.0
8.2
10.0
F. Pierce uses the CAPM to estimate its cost of common equity, rs, and at the time of the analaysis the risk-free rate is 6%, the market risk premium is 8%, and the company's tax rate is 25%. F. Pierce estimates that its beta
now (which is "unlevered" because it currently has no debt) is 0.7. Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure?
Do not round intermediate calculations. Round your answers to two decimal places.
Debt:
%
Equity:
%
WACC:
%
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