Optimal capital structure Your current capital structure is made up of 500,000 shares of common stock and $4 million in private debt. The common stock is currently selling for $27.14 per share. The current T-bill rate is 1.1 %, and the expected return on the market is estimated to be 9 %. Currently your firm’s beta is .78. The rate you pay on your private debt is currently the prime rate plus a spread of 3.75 %. Prime is currently 3.25 %.

You are considering altering your capital structure (not adding money, just shifting). After thorough research, you have determined that a 1 % increase in debt (relative to equity) would result in an increase in your cost of equity of

.02 %. In addition, the 1 % increase in debt would increase your cost of debt by

.05 %.

Given this, and the fact that you do not want to examine other forms of capital, what is your optimal capital structure? Your tax rate is 35 %.