Optimal capital structure. Bobby’s Beer Barn just paid a dividend of $1.06 and has seen their stock price rise to $27.48. However, they are attempting to purchase a new plant that needs capital of $1.5 million. This capital will come from common stock and bank debt. They have the following choices in terms of getting the capital:

If the firm uses option 1, the cost of debt is 5.87% and the cost of equity is 6.10%. The cost of equity is estimated based upon the capital asset pricing model assuming a market risk premium of 7.5% and a risk-free rate of 1.5%. However, for every 20% increase in debt (and resulting 20% decrease in equity), the cost of debt increases by 1%. Also, for every 20% increase in debt, the firm’s beta increases by 0.4. This would then affect the cost of equity. Given a tax rate of 21%, what is the optimal (of these four) capital structure?

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Option Wes Wpd (private debt) 1 0.80 0.20 2 0.60 0.40 3 0.40 0.60 0.20 0.80