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Names: Optimizing the Capital Structure The capital structure of a company is the mix of equity and debt the company uses to finance its capital
Names: Optimizing the Capital Structure The capital structure of a company is the mix of equity and debt the company uses to finance its capital expenditures CAPEX Companies have two ways of funding their CAPEX: equity and debt, that is why in the balance sheet assets equal equity plus liabilities Equity can take two forms: common equity and preferred equity. Debt can take many forms: loans, accounts payable, notes, bonds, etc. The company you will be analyzing uses bonds, common equity, and preferred equity. The capital structure is crucial because it determines the cost of capital of the company. The cost of capital is vital for the NPV calculation. Since the cost of capital is made up of the cost of debt, the cost of common equity, and the cost of preferred equity, the cost of capital is an average of the three costs. You should remember from your introduction to finance class the concept of weighted average cost of capital WACC wacc Where and are the weights or proportions or debt, common equity, and preferred equity the firm uses in the capital structure. is the tax rate. and are the costs of debt, common equity, and preferred equity, respectively. The cost of debt, is multiplied by to find the aftertax cost of debt because interest payments are tax deductible. Common and preferred dividends are not tax deductible. Your objective is to determine the proportions of debt common equity and preferred equity the firm must use to minimize the WACC. Remember that: The total amount of debt D is equal to the number of bonds times the price of each bond. The total amount of common equity is equal to the number of shares times the stock price. The total amount of preferred equity is equal to the number of shares times the preferred stock price. and The cost of debt is equal to the YTM of the company's bond issue. The cost of equity is calculated with the CAPM equation The cost of preferred equity is The company you are analyzing will use number of percent coupon bonds, with years to maturity, par value $ and a quoted price of These bonds pay interest semiannually. shares of common stock selling for $ per share. The stock has a beta of shares of preferred equity selling for $ per share and a preferred dividend of $ per share. The expected return on the market is percent, the riskfree rate is percent, and the tax rate is percent. With all the information above, you must set up an optimization model in Excel to determine the number of bonds common stock shares and preferred stock shares that will minimize the WACC of the company subject to the following constraints: The debttoequity ratio should not exceed The proportion of preferred stock should not exceed The total capital raised by the company should be at least $ The number of bonds common stock shares and preferred stock shares z should be integers. Questions: What is the YTM of the bond issue? What is the cost of equity? What is the cost of preferred equity? How many bonds should the company issue? How many shares of common stock should the company issue? How many shares of preferred stock should the company issue? What is the optimal capital structure of the company? That is how much are and
Names:
Optimizing the Capital Structure
The capital structure of a company is the mix of equity and debt the company uses to finance its capital
expenditures CAPEX
Companies have two ways of funding their CAPEX: equity and debt, that is why in the balance sheet
assets equal equity plus liabilities
Equity can take two forms: common equity and preferred equity.
Debt can take many forms: loans, accounts payable, notes, bonds, etc.
The company you will be analyzing uses bonds, common equity, and preferred equity.
The capital structure is crucial because it determines the cost of capital of the company. The cost of
capital is vital for the NPV calculation.
Since the cost of capital is made up of the cost of debt, the cost of common equity, and the cost of
preferred equity, the cost of capital is an average of the three costs. You should remember from your
introduction to finance class the concept of weighted average cost of capital WACC
wacc
Where and are the weights or proportions or debt, common equity, and preferred equity the
firm uses in the capital structure. is the tax rate. and are the costs of debt, common equity,
and preferred equity, respectively. The cost of debt, is multiplied by to find the aftertax cost
of debt because interest payments are tax deductible. Common and preferred dividends are not tax
deductible.
Your objective is to determine the proportions of debt common equity and preferred equity
the firm must use to minimize the WACC.
Remember that:
The total amount of debt D is equal to the number of bonds times the price of each bond.
The total amount of common equity is equal to the number of shares times the stock
price.
The total amount of preferred equity is equal to the number of shares times the preferred
stock price.
and
The cost of debt is equal to the YTM of the company's bond issue.
The cost of equity is calculated with the CAPM equation
The cost of preferred equity is
The company you are analyzing will use
number of percent coupon bonds, with years to maturity, par value $ and a quoted
price of These bonds pay interest semiannually.
shares of common stock selling for $ per share. The stock has a beta of
shares of preferred equity selling for $ per share and a preferred dividend of $ per
share.
The expected return on the market is percent, the riskfree rate is percent, and the tax rate
is percent.
With all the information above, you must set up an optimization model in Excel to determine the
number of bonds common stock shares and preferred stock shares that will minimize the
WACC of the company subject to the following constraints:
The debttoequity ratio should not exceed
The proportion of preferred stock should not exceed
The total capital raised by the company should be at least $
The number of bonds common stock shares and preferred stock shares z should be
integers.
Questions:
What is the YTM of the bond issue?
What is the cost of equity?
What is the cost of preferred equity?
How many bonds should the company issue?
How many shares of common stock should the company issue?
How many shares of preferred stock should the company issue?
What is the optimal capital structure of the company? That is how much are and
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