ll-equity firm—and its 100,000 shares outstanding. The firm’s federal-plus-state tax rate is 40%.On the basis of statements made in your finance text, you believe that CD’s shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion.In today’s market, the risk-free rate is 6% and the market risk premium is 6%. CD’s unlevered beta is 1.0. CD currently has no debt, so its cost of equity (and WACC) is 12%. If the firm was recapitalized, debt would be issued and the borrowed funds would be used to repurchase stock.
Assume that you have just been hired as business manager of Campus Deli(CD), which is located adjacent to
the campus. Its
expected to be constant over time. Because no expansion capital is required, CD pays out all earnings as
dividends. CD currently has no debt—it is an all-equity firm—and its 100,000 shares outstanding. The firm’s
federal-plus-state tax rate is 40%.On the basis of statements made in your finance text, you believe that CD’s shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion.In today’s market, the risk-free rate is 6% and the market risk premium is 6%. CD’s unlevered beta is 1.0. CD currently
has no debt, so its
borrowed funds would be used to repurchase stock. After speaking with a local investment banker, you obtain the
following estimates of the cost of debt at different debt levels (in thousands of dollars):
| Debt/Asset Ratio | Bond Rating | Yield |
| 0 | --- | --- |
| 0.2 | AA | 8.0% |
| 0.3 | A | 8.5% |
| 0.4 | BBB | 10.0% |
| 0.5 | BB | 12.0% |
| 1) What is the optimal capital structure (or Debt/Asset ratio) in the above table? |
| 2) What is the firm value under the optimal capital structure? |
| 3) What is the stock price under the optimal capital structure? |
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