Lucky cement Co. is trying to establish its optimal capital structure. Its current capital structure consists of 30% debt and 70% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, Rf, is 5%; the market risk premium, RPM, is 6%; and the firm’s tax rate is 40%. Currently, Lucky’s cost of equity is 14%, which is determined by the CAPM. 1. What would be Lucky’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity? 2. What would be Lucky’s estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? 3. Based on cost of equity estimations, should the firm change its capital structure? if yes, which point is optimal if the target is to minimize the cost of equity of the firm?
Lucky cement Co. is trying to establish its optimal capital structure. Its current capital structure consists of 30% debt and 70% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, Rf, is 5%; the market risk premium, RPM, is 6%; and the firm’s tax rate is 40%. Currently, Lucky’s cost of equity is 14%, which is determined by the CAPM. 1. What would be Lucky’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity? 2. What would be Lucky’s estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? 3. Based on cost of equity estimations, should the firm change its capital structure? if yes, which point is optimal if the target is to minimize the cost of equity of the firm?
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
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Lucky cement Co. is trying to establish its optimal capital structure. Its current capital structure consists of 30% debt and 70% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, Rf, is 5%; the market risk premium, RPM, is 6%; and the firm’s tax rate is 40%. Currently, Lucky’s
1. What would be Lucky’s estimated cost of equity if it changed its capital structure to 40% debt and 60% equity?
2. What would be Lucky’s estimated cost of equity if it changed its capital structure to 50% debt and 50% equity?
3. Based on cost of equity estimations, should the firm change its capital structure? if yes, which point is optimal if the target is to minimize the cost of equity of the firm?
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VIEWStep 4 2-Calculation of Cost of Equity if Capital Structure changes to 50% debt and 50% equity:
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