EBK FINANCIAL MANAGEMENT: THEORY & PRAC
15th Edition
ISBN: 9781305886902
Author: EHRHARDT
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 15, Problem 11P
Summary Introduction
To determine: Weighted average cost of capital and firm’s optimal capital structure
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B.F. Pierce & Company is considering changing its capital structure. The company currently has no
debt and no preferred stock, but it would like to add some debt to take advantage of low interest
rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under
various possible capital structures would be as follows:
9.21%
9.07%
8.83%
Market Debt-to-
Value Ratio
8.66%
(WD)
0.00
0.20
0.40
0.60
0.80
Market Equity-to-
Value Ratio
(WE)
1.00
0.80
0.60
0.40
0.20
Market Debt-to-
Equity Ratio
(D/E)
0.00
0.25
0.67
1.50
4.00
The company uses the CAPM to estimate its cost of common equity. Currently the risk-free rate is
5%, the market risk premium is 6%, and the company's tax rate is 35%. The company estimates
that its beta now (which is unlevered because it currently has no debt) is 0.8. Based on this
information, what is the firm's weighted average cost of capital at its optimal capital structure?
Before-Tax Cost of
Debt
(rD)
4.00%
6.00%
8.00%
10.00%
12.00%
B.F. Pierce & Company is considering changing its capital structure. The company currently
has no debt and no preferred stock, but it would like to add some debt to take advantage of
low interest rates and the tax shield. Its investment banker has indicated that the pre-tax
cost of debt under various possible capital structures would be as follows:
8.66%
9.21%
8.83%
Market Debt-to-
Value Ratio
9.07%
(WD)
0.00
0.20
0.40
0.60
0.80
Market Equity-to-
Value Ratio
(WE)
1.00
0.80
0.60
0.40
0.20
Market Debt-to-
Equity Ratio
(D/E)
0.00
0.25
0.67
1.50
4.00
Before-Tax Cost of
Debt
(rD)
5.00%
The company uses the CAPM to estimate its cost of common equity. Currently the risk-free
rate is 4%, the market risk premium is 6%, and the company's tax rate is 25%. The company
estimates that its beta now (which is unlevered because it currently has no debt) is 0.8.
Based on this information, what is the firm's weighted average cost of capital at its optimal
capital structure?
6.00%
7.00%
8.00%
9.00%
Patented Products is considering changing its capital structure. Patented 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:
Debt ratio (wd)
Equity ratio (we)
Debt/Equity ratio
B-T cost of debt
0.0
1.0
0.0
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
Patented uses the CAPM to estimate its cost of common equity, rs, and at the time of the analysis the risk-free rate is 5%, the market risk premium is 6%, and the company’s tax rate is 25%. Patented estimates that its beta now (which is unlevered since it has no debt) is 0.8. 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?
Chapter 15 Solutions
EBK FINANCIAL MANAGEMENT: THEORY & PRAC
Ch. 15 - Prob. 1QCh. 15 - What term refers to the uncertainty inherent in...Ch. 15 - Firms with relatively high nonfinancial fixed...Ch. 15 - “One type of leverage affects both EBIT and EPS....Ch. 15 - Why is the following statement true? Other things...Ch. 15 - Why do public utility companies usually have...Ch. 15 - Why is EBIT generally considered to be independent...Ch. 15 - If a firm went from zero debt to successively...Ch. 15 - Prob. 9QCh. 15 - Prob. 1P
Ch. 15 - Prob. 2PCh. 15 - Ethier Enterprise has an unlevered beta of 1.0....Ch. 15 - Nichols Corporations value of operations is equal...Ch. 15 - Lee Manufacturings value of operations is equal to...Ch. 15 - Dye Trucking raised $150 million in new debt and...Ch. 15 - Schweser Satellites Inc. produces satellite earth...Ch. 15 - Prob. 8PCh. 15 - Prob. 9PCh. 15 - Beckman Engineering and Associates (BEA) is...Ch. 15 - Prob. 11PCh. 15 - A. Fethe Inc. is a custom manufacturer of guitars,...Ch. 15 - Prob. 13SPCh. 15 - Prob. 1MCCh. 15 - Prob. 2MCCh. 15 - Prob. 4MCCh. 15 - Prob. 5MCCh. 15 - Prob. 6MCCh. 15 - Prob. 7MCCh. 15 - Prob. 10MCCh. 15 - Prob. 11MCCh. 15 - Prob. 12MC
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- 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 low interest rates and 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-ValueRatio(wd) Market Equity-to-ValueRatio(ws) Market Debt-to-EquityRatio(D/S) Before-Tax Cost of Debt (rd) 0.0 1.0 0.00 6.0% 0.2 0.8 0.25 7.0 0.4 0.6 0.67* 8.0 0.6 0.4 1.50 9.0 0.8 0.2 4.00 10.0 * Use the exact value of 2/3 in your calculations. 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 5%, and the company's tax rate is 40%. F. Pierce estimates that its beta now (which is "unlevered" because it currently has no debt) is 1.25. Based on this information, what is the firm's optimal capital…arrow_forwardF. 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 Equity Ratio (D/S) 0.00 0.1111 0.2500 0.4286 0.6667 Market Equity-to- Value Ratio (ws) 1.0 0.90 6.0% 6.4 0.80 7.0 8.2 0.70 0.60 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…arrow_forwardWACC 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 low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: F. Pierce uses the CAPM to estimate its cost of common equity, rs and at the time of the analysis the risk-free rate is 5%, the market risk premium is 6%, and the companys tax rate is 40%. F. Pierce estimates that its beta now (which is unlevered because it currently has no debt) is 0.8. Based on this information, what is the firms optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure?arrow_forward
- XYZ Fried Chicken is trying to determine its WACC at the optimal capital structure. The firm now has only debt and equity, and estimates that it will continue to use only debt and equity in the future also. It has determined that the optimal capital structure is given by a debt-to-equity ratio of 0.5. At this ratio, its pre-tax cost of debt is 6%. It has estimated that if it had no debt, then its beta would be 1.2. Assume the risk-free rate is 2% and the market risk premium is 8%. Assume the firm? ’s tax rate is 40%. Based on this information, what is the WACC at the optimal capital structure?arrow_forwardHi-Tech, Inc. has determined that it can minimize its weighted average cost of capital (WACC) by using a debt-equity ratio of 2/3. If the firm's cost of debt is 9% before taxes, the cost of equity is estimated to be 12% before taxes, and the tax rate is 40%, what is the firm's WACC? (The answer choice without supporting calculation will not earn any points).arrow_forwardDiol 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…arrow_forward
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