Cerveceria Modelo Company (CMC) has no debt in its capital structure. Currently, due to some clever tax planning strategies, it pays no corporate income tax. Its equity beta is estimated to be equal to 1.0. Currently the risk free rate is 5% and the expected return on the market is 10%.

a) One of the assistants of the CFO suggests that the firm could lower its weighted average cost of capital (WACC) by borrowing money to finance its operations. Verify if her assertion is true using a range of 0 to 0.8 for D/V ratio. The firm could issue debt at 5% (RD). Is there an optimal capital structure?

Hint: You may use the following formula to compute the firm's beta when it uses debt:

L = u [ 1 + (1-T) D/E] where L is the levered beta; u is the asset beta; T is the corporate tax rate; D/E is the debt equity ratio.

b) Due to a change in government regulations, CMC is likely to lose its tax-exempt status. Compute RE and WACC for various tax rates starting from zero in steps of 10% up to 40% (the maximum rate). Does the corporate tax rate influence the cost of capital and capital structure?