Determining the optimal capital structure

Understanding the optimal capital structure

Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following

financial information to help with the analysis.

Which capital structure shown in the preceding table is Universal Exports Inc.$\text{'}$s optimal capital structure?

Debt ratio $=40\%$; equity ratio $=60\%$

Debt ratio $=70\%$; equity ratio $=30\%$

Debt ratio $=60\%$; equity ratio $=40\%$

Debt ratio $=50\%$; equity ratio $=50\%$

Debt ratio $=30\%$; equity ratio $=70\%$

Consider this case:

Globo$-$Chem Co$.$ currently has a capital structure consisting of $40\%$ debt and $60\%$ equity. However, Globo$-$Chem Co$.\text{'}$s CFO has

suggested that the firm increase its debt ratio to $50\%.$ The current risk$-$free rate is $3\mathrm{.}5\%,$ the market risk premium is $7\mathrm{.}5\%,$ and Globo$-$

Chem Co$.\text{'}$s beta is $1\mathrm{.}10.$

If the firm's tax rate is $40\%,$ what will be the beta of an all$-$equity firm if its operations were exactly the same?

Now consider the case of another company:

U$.$S$.$ Robotics Inc. has a current capital structure of $30\%$ debt and $70\%$ equity. Its current before$-$tax cost of debt is $10\%,$ and its tax

rate is $40\%.$ It currently has a levered beta of $1\mathrm{.}10.$ The risk$-$free rate is $3\mathrm{.}5\%,$ and the risk premium on the market is $7\mathrm{.}5\%.$

U$.$S$.$ Robotics Inc. is considering changing its capital structure to $60\%$ debt and $40\%$ equity. Increasing the firm's level of debt will cause its before$-$tax

cost of debt to increase to $12\%.$ Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm's weighted

average cost of capital $($WACC$)$ be if it makes this change in its capital structure? $($Hint: Do not round intermediate calculations.$)$

Which of the following statements regarding a firm's optimal capital structure are true? Check all that apply.

The optimal capital structure minimizes the firm's cost of equity.

The optimal capital structure minimizes the firm's cost of debt.

The optimal capital structure maximizes the firm's EPS.

The optimal capital structure maximizes the firm's stock price.

The optimal capital structure minimizes the firm's WACC.