Carlisle Industries is trying to determine its optimal capital structure, which now consists of only common equity. The firm will add debt to its capital structure if it minimizes its WACC, but the firm has no plans to use preferred stock in its capital structure. In addition, the firms size will remain the same, so funds obtained from debt issued will be used to repurchase stock. The percentage of shares repurchased will be equal to the percentage of debt added to the firms capital structure. (In other words, if the firms debt to capital ratio increases from 0 to 25%, then 25% of the shares outstanding will be repurchased.)

Its treasury staff has consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firms debt cost at different debt levels.

Debt to capital ratio (wd)	Equity to capital ratio (ws)	Debt to Equity ratio (D/E)	Bond Rating	Before-Tax Cost of Debt (rd)
0.00	1.00	0.0000	AA	5.0%
.25	.75	.3333	A	6.0%
.50	.50	1.000	BBB	8.3%
.75	.25	3.000	BB	11.0%

The firm has total capital of $5 million and 200,000 shares of common stock outstanding. Its EBIT is $500,000 and will not change if debt, at any of the levels shown in the table above, is added to the firms capital structure. Carlisle uses the CAPM to estimate its cost of common equity, r_s. It estimates that the risk-free rate (r_RF) is 3.5%, the market risk premium (RP_M) is 4.5%, and its tax rate is 35%. Carlisles current beta, which is b_U because it has no debt, is 1.25.

1. Calculate the after-tax cost of debt (r_d(1-T)), beta (b_L), cost of equity (r_s), and WACC for each of the capital structures shown in the table above.
2. Considering only the capital structures shown, at what capital structure is WACC minimized and what is the WACC at this capital structure?
3. As an analyst, what is your recommendation to the firms management regarding Carlisles capital structure?