QUESTION 1

You have the following information on Pound Industries Ltd:

Debt/Assets Ratio	Bond Rating	After-tax cost of debt	WACC
0%	n/a	4.8%	12.00%
10	Aa	4.8	11.64
20	Aa	5.0	11.32
30	A	5.4	11.10
40	Baa	6.0	11.04
50	Ba	7.2	11.40
60	Caa	9.0	12.36

(a) What is the companys optimal capital structure and why? (6 marks)

(b) Use theories of capital structure to explain why Pound Industries WACC would at first decrease and then increase as more debt is used in the capital structure. (14 marks)