Question

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 before-tax cost of debt to increase to 10%.

First, solve for US Robotics Inc.’s unlevered beta. _________ (.75, .91, 1.00, .83)

Use US Robotics Inc.’s unlevered beta to solve for the firm’s levered beta with the new capital structure. _______ (1.76, 1.58, 1.67, 1.94)

Use US Robotics Inc.’s levered beta under the new capital structure, to solve for its cost of equity under the new capital structure. _____ (14.130%, 18.055%, 12.560%, 15.700%)

What will the firm’s weighted average cost of capital (WACC) be if it makes this change in its capital structure?

a.) 10.80%

b.) 7.02%

c.) 10.26%

d.) 9.18%

Answer 1