Problem #1

Optimal Capital Structure Inc., an all-equity firm, currently has 15,000 shares outstanding and a perpetual EBIT of $27,000 per year. Optimal Capital Structure Inc. is considering issuing $22,500 in new par bonds to add financial leverage to the firm. The proceeds of the debt issue will be used to repurchase equity. The pre-tax cost of debt is 7.00%. Optimal Capital Structure Inc.'s asset beta is equal to 1.25, the unlevered cost of equity is 12.00% and the tax rate is 35%.

a.What is the value of Optimal Capital Structure Inc. before restructuring?

b.What will be the value of Optimal Capital Structure Inc. after restructuring?

c.What will be Optimal Capital Structure Inc.'s equity beta after restructuring?

d.What will be Optimal Capital Structure Inc.'s cost of equity after restructuring?

e.What will be Optimal Capital Structure Inc.'s cost of capital after restructuring?

f.The share repurchase will be conducted at $12.50 per share. What is the EPS under the unlevered capital structure? The EPS under the levered capital structure?