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 30% 70% 40% 60% 50% 60% 70% 50% 40% 30% WACC 6.02% 9.40% 9.71% 6.75% 9.750% 9.55% 7.15% 10.60% 10.02% 7.55% 11.30% 8.24% 12.80% 10.76% 11.45% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? O Debt ratio -70%; equity ratio -30% O Debt ratio- 60%; equity ratio- 40% O Debt ratio-30%; equity ratio- 70% O Debt ratio 50%; equity ratio 50% O Debt ratio 40%; equity ratio- 60%
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 30% 70% 40% 60% 50% 60% 70% 50% 40% 30% WACC 6.02% 9.40% 9.71% 6.75% 9.750% 9.55% 7.15% 10.60% 10.02% 7.55% 11.30% 8.24% 12.80% 10.76% 11.45% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? O Debt ratio -70%; equity ratio -30% O Debt ratio- 60%; equity ratio- 40% O Debt ratio-30%; equity ratio- 70% O Debt ratio 50%; equity ratio 50% O Debt ratio 40%; equity ratio- 60%
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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Concept explainers
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Question
Transcribed Image Text: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
70%
30%
40%
60%
50%
50%
60%
40%
70%
30%
T
6.02%
Consider this case:
4₂
9.40%
6.75% 9.750%
7.15% 10.60% 10.02%
7.55%
11.30% 10.78%
8.24% 12.80% 11.45%
WACC
9.71%
9.55%
Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure?
O Debt ratio- 70%; equity ratio -30%
O Debt ratio-60%; equity ratio- 40%
O Debt ratio-30%; equity ratio = 70%
O Debt ratio 50%; equity ratio 50%
O Debt ratio-40%; equity ratio- 60%
Globex Corp. 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 6%, and it will face a tax rate of 25%
What will Globex Corp.'s beta be if it decides to make this change in its capital structure?
Now consider the case of another company
1.40
1.61
1.26
US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its curre 1.47-tax cost of debt is 6%, and its tax rate
is 25%. It currently has a levered beta of 1.10. The risk-free rate in 35%
Transcribed Image Text: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%, and its tax rate
is 25%. It currently has a levered beta of 1.10. The risk-free rate is 3.5%, and the risk premium on the market is 7.5%. US 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 8%.
First, solve for US Robotics Inc.'s unlevered beta.
Use US Robotics Inc.'s unlevered beta to solve for the firm's levered beta with the new capital structure.
Use US Robotics Inc.'s levered beta under the new capital structure, to solve for its cost of equity under the new capital structure.
What will the firm's weighted average cost of capital (WACC) be if it makes this change in its capital structure?
7.21%
O 6.18 %
10.30%
O 8.24%
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