Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Assume that your company is trying to determine its optimal capital structure, which consists only of debt and common stock. To estimate the cost
Assume that your company is trying to determine its optimal capital structure, which consists only of debt and common stock. To estimate the cost of debt, the company has produced the following table: Percent Financed With Debt Debt/Equity Ratio 0.10 0.20 0.30 0.40 0.50 Percent Financed 9 With Equity 0.90 0.80 0.10/0.90 = 0.11 0.20/0.80 = 0.25 Band Rating AA Before-Tax Cost of Debt 7.0% A 7.2% 0.70 0.30/0.70 = 0.43 A 8.0% 0.60 0.50 0.40/0.60 = 0.67 0.50/0.50 = 1.00 BB 8.8% B 9.6% Now assuine that the company's tax rate is 40 percent, that the company uses the CAPM to estimate its cost of common equity, KS, that the risk-free rate is 5 percent and the market risk premium is 6 percent. Finally assume that if it has no debt its WACC would be equal to its cost of equity which would be equal to 11 percent (you should now be able to determine its "unlevered beta," bu). Given this information, determine the firm's cost of capital if it finances with 40 percent debt and 60 percent equity. 9.26% 9.86% 9.56% 8.96% 10.16%
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started