Question
Company AAAs capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
Company AAAs capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
Percent of debt: (Wd) | Percent of equity: (We) | Bond rating: | Before tax cost of debt: Rd |
0.3 | 0.7 | A | 8.0% |
0.4 | 0.6 | BBB | 8.8% |
0.5 | 0.5 | BB | 9.6% |
The companys tax rate is 40% and uses the CAPM to estimate its cost of common equity. The risk-free rate = 5% and the market risk premium = 6%. The company estimates that if it had no debt its beta would be 1.0. (Its unlevered beta equals 1.0). The firm expects zero growth (g=0). The expected FCF (free cash flow) is $100 million per year.
- Based on the above information, calculate AAAs optimal capital structure, the cost of capital at this optimal capital structure.
- Calculate the firm value at this optimal capital structure.
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