Question

**Problem 21-05**

- Given the following, determine the firm’s optimal capital
structure:
**Debt/Assets****After-Tax Cost of Debt****Cost of Equity**0 % 6 % 13 % 10 6 13 20 7 13 30 7 13 40 9 14 50 10 15 60 12 16 Round your answers for capital structure to the nearest whole number and for the cost of capital to one decimal place.

The optimal capital structure: _______ % debt and ______% equity with a cost of capital of _____%

- If the firm were using 10 percent debt and 90 percent equity,
what would that tell you about the firm’s use of financial
leverage? Round your answer for the cost of capital to one decimal
place.
If the firm uses 10% debt financing, it would be using too little financial leverage. At that combination the cost of capital is ______%. The firm could lower the cost of capital by substituting debt for equity.

- If the firm were using 30 percent debt and 70 percent equity
and earned a return of 11.5 percent on an investment, would this
mean that stockholders would receive less than their required
return of 13.0 percent?
If the firm earns 11.5% on an investment, the stockholders will earn more than their required 13.0%.

What return would stockholders receive? Round your answer to one decimal place.

________ %

Answer #1

A | B | A + B | ||||

Debt/Assets | Equity/Assets | After-Tax Cost of Debt | Cost of Equity | (Debt/Assets) * After tax cost of debt | (Equity/Assets) * Cost of Equity | WACC |

0% | 100% | 6% | 13% | 0.0% | 13.0% | 13.0% |

10% | 90% | 6% | 13% | 0.6% | 11.7% | 12.3% |

20% | 80% | 7% | 13% | 1.4% | 10.4% | 11.8% |

30% |
70% |
7% |
13% |
2.1% |
9.1% |
11.2% |

40% | 60% | 9% | 14% | 3.6% | 8.4% | 12.0% |

50% | 50% | 10% | 15% | 5.0% | 7.5% | 12.5% |

60% | 40% | 12% | 16% | 7.2% | 6.4% | 13.6% |

The optimal capital structure: 30% debt and 70% equity with a cost of capital of 11.2% |

Problem 21-03
A firm’s current balance sheet is as follows:
Assets
$
140
Debt
$
42
Equity
$
98
What is the firm’s weighted-average cost of capital at various
combinations of debt and equity, given the following information?
Round your answers to one decimal place.
Debt/Assets %
After-Tax Cost of Debt %
Cost of Equity %
Cost of Capital
0%
8%
11%
%
10
8
11
%
20
8
11
%
30
9
12
%
40
10
12
%
50...

Problem 21-04
The financial manager of a firm determines the following
schedules of cost of debt and cost of equity for various
combinations of debt financing:
Debt/Assets
After-Tax Cost of Debt
Cost of Equity
0
%
4
%
8
%
10
4
8
20
4
8
30
5
9
40
6
10
50
8
12
60
10
14
70
12
16
Find the optimal capital structure (that is, optimal
combination of debt and equity financing). Round your answers for
the...

The current capital structure is 35 percent debt and 65 percent
equity. The after-tax cost of our debt is 6 percent, and the cost
of our equity (in retained earnings) is 13 percent. Please compute
the firm’s current weighted average cost of capital. One of the
things we discussed with our investor, due to the current low
interest rate environment, is moving our capital structure to 45
percent debt and 55 percent equity. With this new structure, the
after-tax cost...

A firm’s optimal capital structure is 45% debt, 10% preferred
stock, and 45% common equity. The firm’s tax rate is 43%. The beta
coefficient of the firm’s debt is 0.2, the risk-free rate of
interest is 2.7% and the market risk premium (RM-RF) is 7.3%. The
firm’s preferred stock currently has a price of $84 and it carries
a dividend of $10 per share. Currently, the price of a share of
common equity was $29 per share. The last dividend...

Given the following choices, what is the optimal capital
structure for Chip Co.? (Assume that the company's growth rate is
2%.)
Dividends
Cost of
Debt Ratio
Per Share
Equity (r s)
0%
$5.50
11.5%
25
6.00
12.0
40
6.50
13.0
50
7.00
14.0
75
7.50
15.0
0% debt; 100% equity
25% debt; 75% equity
40% debt; 60% equity
50% debt; 50% equity
75% debt; 25% equity

A firm’s capital structure is 10% debt and 90% common equity.
The tax rate is 25%, the interest rate on new debt is 12%, and the
cost of common equity is 16.15%. The firm’s weighted average cost
of capital (WACC) is what %. This is calculated to two decimal
places using the following formula: WACC = WCS × CCS + WPS × CPS +
WD × CD

Problem 21-01
HBM, Inc has the following capital structure:
Assets
$
350,000
Debt
$
87,500
Preferred stock
17,500
Common stock
245,000
The common stock is currently selling for $13 a share, pays a
cash dividend of $0.50 per share, and is growing annually at 4
percent. The preferred stock pays a $7 cash dividend and currently
sells for $85 a share. The debt pays interest of 7.0 percent
annually, and the firm is in the 30 percent marginal tax
bracket....

Evans Technology has the following capital structure. Debt 35 %
Common equity 65 The aftertax cost of debt is 8.50 percent, and the
cost of common equity (in the form of retained earnings) is 15.50
percent.
a. What is the firm’s weighted average cost of capital? (Do not
round intermediate calculations. Input your answers as a percent
rounded to 2 decimal places.) An outside consultant has suggested
that because debt is cheaper than equity, the firm should switch to
a...

1. Capital structure decisions and firm
value
Why focus on the optimal capital structure?
A company’s capital structure decisions address the ways a
firm’s assets are financed (using debt, preferred stock, and common
equity capital) and is often presented as a percentage of the type
of financing used.
As with all financial decisions, a firm should try to establish
a capital structure that maximizes the stock price, or shareholder
value. This is called the optimal capital structure; it is also...

ACCM Inc. is considering adding leverage to its capital
structure. The firm’s managers believe they can issue more debt to
exploit the tax benefit of leverage. However, they also recognize
that higher debt increases the risk of financial distress. Based on
simulation of the firm’s future cash flows, the managers have made
the following estimates (in millions of dollars) for different
levels of debt (%) in the firm capital structure.
Debt level
10%
20%
30%
40%
50%
PV(Interest tax shield)...

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