EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN: 9781337514835
Author: MOYER
Publisher: CENGAGE LEARNING - CONSIGNMENT
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Chapter 13, Problem 4P
a)
Summary Introduction
To determine: The optimal capital structure of firm.
b)
Summary Introduction
To determine: The difference between weighted cost of capital and optimal capital structure.
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Aaron Athletics is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common equity. In order to estimate the cost of capital at various debt levels the company has constructed the following table:
Percent financed with debt (wD)
Percent financed with equity (ws)
Before tax cost of debt
0.10
0.90
7.0%
0.20
0.80
7.2%
0.30
0.70
8.0%
0.40
0.60
8.8%
0.50
0.50
9.6%
The company uses the CAPM to estimate its cost of equity, rS . The risk-free rate is 4% and the market risk premium is 5%. Aaron estimates that if it had no debt its beta would be 1.0. (It’s unlevered beta equals 1.0). The company’s tax rate is 40%.
On the basis of this information, what is the company’s optimal capital structure, and what is the WACC at that capital structure? (Show your calculations at each debt level).
Ilumina Corp is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
Percent financed with debt (wd)
Percent financed with equity (wc)
Debt-to-equity ratio (D/S)
After-tax cost of debt (%)
0.25
0.75
0.25/0.75 = 0.33
6.9%
0.35
0.65
0.35/0.65 = 0.5385
7.1%
0.50
0.50
0.50/0.50 = 1.00
8.0%
The company uses the CAPM to estimate its cost of common equity, rs. The risk-free rate is 5% and the market risk premium is 6%. Ilumina estimates that its beta with 10% debt is 1. The company’s tax rate, T, is 40%. On the basis of this information, what is the company’s optimal capital structure, and what is the firm’s cost of capital at this optimal capital structure? (Please show work)
The activity ratios measure which of the following?
Select one:
O a the efficiency of the company's supply chain
O b. the efficiency with which a company generates sales from its assets
Oc the profitability of the company's activities
Od the production efficiency of a company's fixed assets
If the assumption of financial distress costs is added, then Modigliani and Miller (with taxes) predicts that the optimal capital
structure is 100% debt
Select one:
O True
O False
Chapter 13 Solutions
EBK CONTEMPORARY FINANCIAL MANAGEMENT
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