Problem 21-12

The financial manager has determined the following schedules for the cost of funds:

Debt ratio		Cost of Debt		Cost of Equity
0	%	3	%	12	%
10		3		12
20		3		12
30		3		12
40		3		13
50		5		14
60		6		15

1. Determine the firms optimal capital structure. Round your answer to two decimal places.

   The optimal capital structure consists of % debt resulting in the cost of capital equal to %.

2. Construct a simple pro forma balance sheet that shows the firms optimal combination of debt and equity for its current level of assets. Round your answers to the nearest dollar.

   Balance Sheet
   Assets	$700		Debt	$
   			Equity
   				$	700

3. An investment costs $500 and offers annual cash inflows of $119 for five years. Should the firm make the investment? Use Appendix D to answer the question. Round your answer to the nearest whole number.

   The investment -Select-shouldshould not be made since the internal rate of return that is % -Select-exceedsis lower thanItem 7the cost of capital.

4. If the firm makes this additional investment, how should its balance sheet appear? Round your answers to the nearest dollar.

   Balance Sheet
   Assets	$		Debt	$
   			Equity
   				$

5. If the firm is operating with its optimal capital structure and a $500 asset yields 20.0 percent, what return will the stockholders earn on their investment in the asset? Round your answer to two decimal places.

   %