Assume that you have just been hired as business manager of Campus Deli(CD), which is located adjacent to the campus. Its Free Cash Flow(FCF) is $30,000. Because the universitys enrollment is capped, FCF is expected to be constant over time. Because no expansion capital is required, CD pays out all earnings as dividends. CD currently has no debtit is an all-equity firmand its 100,000 shares outstanding. The firms federal-plus-state tax rate is 40%.

On the basis of statements made in your finance text, you believe that CDs shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion.

In todays market, the risk-free rate is 6% and the market risk premium is 6%. CDs unlevered beta is 1.0. CD currently

has no debt, so its cost of equity (and WACC) is 12%. If the firm was recapitalized, debt would be issued and the

borrowed funds would be used to repurchase stock. After speaking with a local investment banker, you obtain the

following estimates of the cost of debt at different debt levels (in thousands of dollars):

	Debt/Asset Ratio		Bond Rating		Yield
	0		---		---
	0.2		AA		8.0%
	0.3		A		8.5%
	0.4		BBB		10.0%
	0.5		BB		12.0%

Now answer the following questions:

1) What is the optimal capital structure (or Debt/Asset ratio) in the above table?

2) What is the firm value under the optimal capital structure?

3) What is the stock price under the optimal capital structure?