Question
Ilumina Corp is trying to determine its optimal capital structure. The company's capital structure consists of debt and common stock. In order to estimate the
Ilumina Corp is trying to determine its optimal capital structure. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
Percent financed with debt Percent financed with equity Debt to equity ratio (d/s) Fter tax cost of debt 0.25 0.75 0.25/0.75 = 0.33 7.5 0.35 0.65 0.35/0.6 =0.5385 8.4 0.50 0.50 0.50/0.50 = 1 9.0
The company uses the CAPM to estimate its cost of common equity, rs. The risk-free rate is 5% and the market risk premium is 6%. Ilumina estimates that its beta with 10% debt is 1. The company's tax rate, T, is 40%. On the basis of this information, what is the company's optimal capital structure, and what is the firm's cost of capital at this optimal capital structure?
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