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King Fisher Aviation has a target capital structure of 72 percent common stock and 28 percent...

King Fisher Aviation has a target capital structure of 72 percent common stock and 28 percent debt. Their cost of equity is 12 percent and the cost of debt is 5 percent. The tax rate is 40 percent. WACC is 9.48%. Evaluate King Fisher's target capital structure. What are your recommendations? Consider the impact of taxes and explain your reasoning. Please provide analysis do not calculate WACC as it is already given.

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Answer #1

Answer-

After tax cost of debt=5(1-tax rate)

5(1-0.4)=3%

WACC=Respective costs*Respective weight

(0.72*12)+(0.28*3)

=9.48%

Consider the impact of taxes and explain your reasoning.The optimal capital structure is the mix of debt and equity that maximizes a firm’s return on capital, thereby maximizing its value. Because of tax advantages on debt issuance, for example, the ability to withhold interest payments from taxable income, issuing debt will nine times out of ten be cheaper than issuing new equity. However, the cost of issuing new debt will be greater than the cost of issuing new equity. The task at hand here is that management must identify the ideal combination of financing, which is the capital structure where the firm’s value is be maximized because the cost of capital was minimized.

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