Question

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 |
rdrd |
rsrs |
WACC |
---|---|---|---|---|

30% | 70% | 7.00% | 10.50% | 8.61% |

40% | 60% | 7.20% | 10.80% | 8.21% |

50% | 50% | 7.70% | 11.40% | 8.01% |

60% | 40% | 8.90% | 12.20% | 8.08% |

70% | 30% | 10.30% | 13.50% | 8.38% |

Which capital structure shown in the preceding table is Universal Exports Inc.’s optimal capital structure? ____________________

Debt ratio = 60%; equity ratio = 40%

Debt ratio = 70%; equity ratio = 30%

Debt ratio = 40%; equity ratio = 60%

Debt ratio = 30%; equity ratio = 70%

Debt ratio = 50%; equity ratio = 50%

Consider this case:

Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 60% equity and 40% debt. The firm’s cost of debt will be 6%, and it will face a tax rate of 35%.

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:

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 35%. It currently has a levered beta of 1.15. The risk-free rate is 3.5%, and the risk premium on the market is 8%. 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?

8.2%

8.7%

7.7%

10.2%

Answer #1

**option e**. is correct option Universal Exports
Optimal Capital Structure . Debt and Equity at 50% because WACC is
minimum..

Glob Chem Beta levered if it decides to change the capital
structure

= Beta unlevered*(1+(1-tax rate)*Debt/ Equity)
=1*(1+(1-35%)*40%/60%) =**1.43**

US robotics Unlevered Beta =Beta levered/(1+(1-tax
rate)*Debt/Equity) = 1.15/(1+(1-35%)*30/70) = 0.8994 or
**0.90**

US robotics levered Beta =Beta unlevered*(1+(1-tax
rate)*Debt/Equity) = 0.8994*(1+(1-35%)*60/40) = 1.7764 or
1.78

Cost of Equity under new beta = Risk Free Rate + Beta *(Market
Return - Risk Free Rate) =3.5%+1.7764*8%
=**17.71%**

Weight of Debt* Cost of Debt*(1- Tax Rate)+ Weight of Equity *
Cost of Equity =60%*8%*(1-35%)+40%*17.71%= 10.41% or 10.2%
(**option d is correct option**)

Understanding the optimal capital structure
Review this situation: Transworld Consortium Corp. is trying to
identify its optimal capital structure. Transworld Consortium Corp.
has gathered the following financial information to help with the
analysis.
Debt Ratio
Equity Ratio
EPS
DPS
Stock Price
30%
70%
1.25
0.55
36.25
40%
60%
1.40
0.60
37.75
50%
50%
1.60
0.65
39.50
60%
40%
1.85
0.75
38.75
70%
30%
1.75
0.70
38.25
1) Which capital structure shown in the
preceding table is Transworld Consortium Corp.’s optimal...

4. Determining the optimal capital
structure
US Robotics Inc. has a current capital structure of 30% debt and
70% equity. Its current before-tax cost of debt is 8%, and its tax
rate is 25%. It currently has a levered beta of 1.10. The risk-free
rate is 2.5%, 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...

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%, 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...

Review the following situation:
Transworld Consortium Corp. is trying to identify its optimal
capital structure. Transworld Consortium Corp. has gathered the
following financial information to help with the analysis.
Debt Ratio
(%)
Equity Ratio
(%)
EPS
DPS
Stock
Price
30
70
1.55
0.34
22.35
40
60
1.67
0.45
24.56
50
50
1.72
0.51
25.78
60
40
1.78
0.57
27.75
70
30
1.84
0.62
26.42
Which capital structure shown in the preceding table is
Transworld Consortium Corp.’s optimal capital structure?
Debt...

1.Transworld Consortium Corp. is trying to
identify its optimal capital structure. Transworld Consortium Corp.
has gathered the following financial information to help with the
analysis.
Debt Ratio (%)
Equity Ratio (%)
rd%rd%
rs%rs%
WACC (%)
30
70
6.02
9.40
9.71
40
60
6.75
9.750
9.55
50
50
7.15
10.60
10.02
60
40
7.55
11.30
10.78
70
30
8.24
12.80
11.45
Which capital structure shown in the preceding table is
Transworld Consortium Corp.’s optimal capital structure?
A) Debt ratio = 40%;...

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