Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Impact of Financing on Firm Value Aaron Athletics is trying to determine its optimal capital structure. The company's capital structure consists of debt and common
Impact of Financing on Firm Value Aaron Athletics 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 (wa) 0.10 0.20 0.30 0.40 0.50 Percent financed with equity (we) 0.90 0.80 0.70 0.60 0.50 Debt-to-equity ratio (D/S) 0.10/0.90 = 0.11 0.20/0.80 = 0.25 0.30/0.70 = 0.43 0.40/0.60 = 0.67 0.50/0.50 = 1.00 Bond rating AAA AA A BBB BB Before-tax cost of debt 7.0% 7.2 8.0 8.8 9.6 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%. Aaron estimates that if it had no debt its "assets beta, ba, and tax rate are as given below. Asset Beta ba 1.76 Tax Rate 27.6 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 assuming that the beta of debt is zero when there is no debt but increases by .1 for each 10% addition in debt
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