Answered step by step
Verified Expert Solution
Question
1 Approved Answer
B.F. Pierce & Company is considering changing its capital structure. The company currently has no debt and no preferred stock, but it would like to
B.F. Pierce & Company is considering changing its capital structure. The company currently has no debt and no preferred stock, but it would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: Market Debt-to- Market Equity-to- Market Debt-to- Before-Tax Cost of Value Ratio Value Ratio Equity Ratio Debt (wp) (we) (D/E) (rp) 0.00 1.00 0.00 5.00% 0.20 0.80 0.25 6.00% 0.40 0.60 0.67 7.00% 0.60 0.40 1.50 8.00% 0.80 0.20 4.00 9.00% The company uses the CAPM to estimate its cost of common equity. Currently the risk-free rate is 4%, the market risk premium is 6%, and the company's tax rate is 25%. The company estimates that its beta now (which is unlevered because it currently has no debt) is 0.8. Based on this information, what is the firm's weighted average cost of capital at its optimal capital structure? O 8.83% O 9.21% O 8.66% 09.07%
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