Assume you have just been hired as a business manager of Berthas Burgers, a regional hamburger restaurant chain. The companys EBIT was $100 million last year and is not expected to grow. The firm is currently financed with all equity and it has 10 million shares outstanding. When you took your corporate finance course, your instructor stated that most firms owners would be financially better off if the firms used some debt. When you suggested this to your new boss, he encouraged you to pursue the idea. As a first step, assume that you obtained from the firms investment banker the following estimated costs of debt for the firm at different capital structures:

% Financed With Debt rd

0% ---

25 9.0%

30 9.5

35 10.0 40 10.5

If the company were to recapitalize, debt would be issued, and the funds received would be used to repurchase stock. Bernies Burgers is in the 25 percent state-plus-federal corporate tax bracket, its unleveraged beta is 1.10, the risk-free rate is 6 percent, and the expected return on the market is 11 percent.

a. Calculate the leveraged beta for each capital structure.

b. Calculate the cost of equity for each capital structure.

c. Calculate the cost of capital for each capital structure.

d. Calculate the corporate value for each capital structure.

e. What is the optimal capital structure?

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