Bundle: Fundamentals of Financial Management, 14th + LMS Integrated for MindTap Finance, 1 term (6 months) Printed Access Card
14th Edition
ISBN: 9781305776494
Author: Eugene F. Brigham, Joel F. Houston
Publisher: Cengage Learning
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Textbook Question
Chapter 14, Problem 14SP
WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm dots not currently use
Elliott uses the
- a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structure?
- b. If Elliott's managers anticipate that the company's business risk will increase in the future, what effect would this likely have on the firm's target capital structure?
- c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott's target capital structure?
- d. Plot a graph of the after-tax cost of debt, the
cost of equity , and the WACC versus (1) - e. the debt/capital ratio and (2) the debt /equity ratio.
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Diol Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. To estimate how much its debt would cost at different debt levels, the company’s treasury staff has consulted with investment bankers and, on the basis of those discussions, has created the following table:
Structure
Market Debt-to-Value Ratio (Wd)
Market Equity-to-Value Ratio (Ws)
Bond Rating
Pre-tax Cost of Debt (rd)
A
0.0
1.0
AA
9.0%
B
0.2
0.8
BBB
10.5%
C
0.5
0.5
BB
11.6%
D
0.6
0.4
C
12.7%
E
0.75
0.25
D
14.0%
Diol uses the CAPM to estimate its cost of common equity, rs. The company estimates that the risk-free rate is 7%; the market risk is 13%, and the company’s tax rate is 20%. Diol estimates that if it had no debt, its “unlevered” beta, bU, would be 1.3.
What is the…
WACC and Optimal Capital Structure
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 Debt-to-Value Ratio (wd)
Market Equity-to-Value Ratio (ws)
Market Debt-toEquity Ratio (D/S)
Before-Tax Cost ofDebt (rd)
0.0
1.0
0.00
6.0
%
0.10
0.90
0.1111
6.4
0.20
0.80
0.2500
7.0
0.30
0.70
0.4286
8.2
0.40
0.60
0.6667
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 5%, the market risk premium is 7%, 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 0.9. Based on this information, what is the firm's optimal…
WACC and Optimal Capital Structure
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:
Equity:
Market Debt-to-
Value Ratio (wa)
0.0
0.10
0.20
0.30
0.40
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 5%, the market risk premium is 7%, 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:
WACC:
Market Equity-to-…
Chapter 14 Solutions
Bundle: Fundamentals of Financial Management, 14th + LMS Integrated for MindTap Finance, 1 term (6 months) Printed Access Card
Ch. 14 - Changes in sales cause changes in profits. Would...Ch. 14 - Would each of the following increase, decrease, or...Ch. 14 - Discuss the following statement: All else equal,...Ch. 14 - Prob. 4QCh. 14 - Prob. 5QCh. 14 - Why do public utilities generally use different...Ch. 14 - Why is EBIT generally considered independent of...Ch. 14 - Is the dept level that maximizes a firms expected...Ch. 14 - If a firm goes from zero dept to successively...Ch. 14 - Prob. 10Q
Ch. 14 - A firm is about to double its assets to serve its...Ch. 14 - Prob. 1PCh. 14 - Prob. 2PCh. 14 - Prob. 3PCh. 14 - UNLEVERED BETA Harley Motors has 10 million in...Ch. 14 - FINANCIAL LEVERAGE EFFECTS Firms HL and LL are...Ch. 14 - BREAK-EVEN ANALYSIS The Weaver Watch Company sells...Ch. 14 - Prob. 7PCh. 14 - HAMADA EQUATION Cyclone Software Co. is trying to...Ch. 14 - RECAPITALIZATION Tapley Inc. currently has total...Ch. 14 - BREAKEVEN AND OPERATING LEVERAGE a. Given the...Ch. 14 - RECAPITALIZATION Currently, Bloom Flowers Inc. has...Ch. 14 - BREAKEVEN AND LEVERAGE Wingler Communications...Ch. 14 - FINANCING ALTERNATIVES The Severn Company plans to...Ch. 14 - WACC AND OPTIMAL CAPITAL STRUCTURE Elliott...Ch. 14 - OPTIMAL CAPITAL STRUCTURE Assume that you have...Ch. 14 - Prob. 1TCLCh. 14 - Exploring the Capital Structures for Four...
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