The management of CRB plc wants to estimate the cost of its capital. The companys Chief Financial Officer (CFO) has contacted you to assist in this task.

CRB currently has in issue 2,000,000 shares that are trading at 8.5 per share, with an equity beta of 0.8. It also has in issue perpetual debt with face value of 6,000,000 (par 100 block) bearing a coupon rate of 5%, currently trading at a premium of 20% on par. The risk free rate is 3% and the expected market return is 11%.

a. Assume that the company does not pay corporate tax, calculate the current Weighted Average Cost of Capital (WACC) of CRB.

The companys CFO met with you and explained that the firm decided to change its capital structure to 40% debt and 60% equity. Assume a world where there are no taxes or costs of financial distress and where Modigliani and Millers (1958) propositions 1-2 hold.

Based on the new capital structure (40% debt and 60% equity), what will be the WACC of CRB? Justify your answer.

c. Critically discuss Modigliani and Millers view that capital structure does not affect the value of the firm.

d. Critically discuss the trade-off theory with bankruptcy costs view that an optimal capital structure exists.