Engro Corporation's manager is currently tyring to determine its optimal capital structure. The company only uses debt and common equity financing. The finance manager of the company has shared the following information regarding the debt cost at different levels. Debt to Asset Ratio Bond Rating Before Tax Cost of Debt Other information: 0.0 A 7.0% Tax rate = 40% 0.2 BBB 8.0% Risk free rate = 5% 0.4 BB 10.0% Market Risk Premium = 6% 0.6 C 12.0% Unleveraged Beta (BU)=1.2 0.8 D 15.0% The finance manager wants to use the CAPM model to estimate the cost of common equity, a) What is the firms optimal capital structure, and what would be its WACC at the optimal capital structure? (6 marks) b) If the finance manager anticipates that the companys business risk will increase in the future, what effect would this likely have on the firms Wacc? (3 marks) c) If the government were to dramatically increase the corporate tax rate, what effect would this likely have on the WACC? (3 marks)

Steel Mill Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, the manager does not pay any dividends and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Barretts stock. The pension fund manager has estimated Barretts free cash flows for the next 4 years as follows: $5 million, $7 million, $12 million, and $16 million. After the fourth year, free cash flow is projected to grow at a constant 5%. Barretts WACC is 10%, its debt and preferred stock total $50 million, and it has 10 million shares of common stock outstanding. a. What is the present value of the free cash flows projected during the next 4 years? (1 mark) b. What is the firms terminal value? (1 marks) c. What is the firms total value today? (2 marks) d. What is an estimate of Barretts price per share? (2 marks) e. If you bought a share of common stock, you would probably expect to receive dividends plus an eventual capital gain. Would the distribution between the dividend yield and the capital gains have an impact on the stock price ?