Pinder Inc. in the U.S. is examining its capital structure, with the intent of arriving at an optimal debt ratio. It currently has no debt and has a beta of 1.5. The riskless interest rate and the market risk premium are is 9% and 5.5%, respectively. Your research indicates that the debt rating will be as follows at different debt levels:

D/(D+E) Rating Interest rate

0% AAA 10%

10% AA 10.5%

20% A 11%

30% BBB 12%

40% BB 13%

50% B 14%

60% CCC 16%

70% CC 18%

80% C 20%

90% D 25%

The firm currently has 1 million shares outstanding at $20 per share. Assume corporate tax rate for this firm is 40%.

(a) What is the firm's optimal debt ratio (only consider the above 10 choices from 0% to 90%). Please use the cost of capital approach in which you need to check how the cost of debt (using the debt rating above) and the cost of equity (using the equation for levered beta) would change at each debt ratio.

(b) What is the current market value of the firm? After the firm restructures its financial structure at the optimal debt level you calculated in (a), what will be the value of the firm? Assume that the firms assets are expected to generate a constant annual cash flow forever, which will not be affected by financing policy.