Question
4. Determining the optimal capital structure Understanding the optimal capital structure Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure.
4. Determining the optimal capital structure
Understanding the optimal capital structure
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% | 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 Universal Exports Inc.s optimal capital structure?
Debt ratio = 60%; equity ratio = 40%
Debt ratio = 70%; equity ratio = 30%
Debt ratio = 30%; equity ratio = 70%
Debt ratio = 40%; equity ratio = 60%
Debt ratio = 50%; equity ratio = 50%
Consider this case:
Globex Corp. has a capital structure that consists of 30% debt and 70% equity. The firms current beta is 1.15, but management wants to understand Globex Corp.s market risk without the effect of leverage.
If Globex Corp. has a 25% tax rate, what is its unlevered beta?
0.96
1.04
0.78
0.87
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 10%, and its tax rate is 25%. It currently has a levered beta of 1.15. The risk-free rate is 3.5%, 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 firms level of debt will cause its before-tax cost of debt to increase to 12%.
First, solve for US Robotics Inc.s unlevered beta. ___?___
Use US Robotics Inc.s unlevered beta to solve for the firms 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 firms weighted average cost of capital (WACC) be if it makes this change in its capital structure?
8.68%
13.64%
10.54%
12.40%
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