Understanding the optimal capital structure Review this situation: Transworld Consortium Corp. is trying to identify its optimal capital structure. Transworld Consortium Corp. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio 30% 70% 40% 60% 50% 50% 60% 40% 70% 30% re 7.00% 7.20% 7.70% 8.90% 10.30% r s WACC 10.50% 8.61% 10.80% 8.21% 11.40% 8.01% 12.20% 8.08% 13.50% 8.38% Which capital structure shown in the preceding table is Transworld Consortium Corp.'s optimal capital structure? O Debt ratio = 50%; equity ratio = 50% O Debt ratio = 70%; equity ratio = 30% O Debt ratio = 40%; equity ratio = 60% O Debt ratio = 30%; equity ratio = 70% O Debt ratio = 60%; equity ratio = 40% Globex Corp. currently has a capital structure consisting of 35% debt and 65% equity. However, Globex Corp.'s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3.5%, the market risk premium is 7.5%, and Globex Corp.'s beta is 1.25. If the firm's tax rate is 40%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 10%, and its tax rate is 40%. It currently has a levered beta of 1.25. The risk-free rate is 3.5%, and the risk premium on the market is 7.5%. U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-tax cost of debt to increase to 12%. First, solve for U.S. Robotics Inc.'s unlevered beta. Relever U.S. Robotics Inc.'s beta using the firm's new capital structure. | Use U.S. Robotics Inc.'s levered beta under the new capital structure, to solve for its cost of equity under the new capital structure. I What will the firm's weighted average cost of capital (WACC) be if it makes this change in its capital structure? 11.4% 9.1% 8.0% 8.6% Understanding the optimal capital structure Review this situation: Transworld Consortium Corp. is trying to identify its optimal capital structure. Transworld Consortium Corp. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio 30% 70% 40% 60% 50% 50% 60% 40% 70% 30% re 7.00% 7.20% 7.70% 8.90% 10.30% r s WACC 10.50% 8.61% 10.80% 8.21% 11.40% 8.01% 12.20% 8.08% 13.50% 8.38% Which capital structure shown in the preceding table is Transworld Consortium Corp.'s optimal capital structure? O Debt ratio = 50%; equity ratio = 50% O Debt ratio = 70%; equity ratio = 30% O Debt ratio = 40%; equity ratio = 60% O Debt ratio = 30%; equity ratio = 70% O Debt ratio = 60%; equity ratio = 40% Globex Corp. currently has a capital structure consisting of 35% debt and 65% equity. However, Globex Corp.'s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3.5%, the market risk premium is 7.5%, and Globex Corp.'s beta is 1.25. If the firm's tax rate is 40%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 10%, and its tax rate is 40%. It currently has a levered beta of 1.25. The risk-free rate is 3.5%, and the risk premium on the market is 7.5%. U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm's level of debt will cause its before-tax cost of debt to increase to 12%. First, solve for U.S. Robotics Inc.'s unlevered beta. Relever U.S. Robotics Inc.'s beta using the firm's new capital structure. | Use U.S. Robotics Inc.'s levered beta under the new capital structure, to solve for its cost of equity under the new capital structure. I What will the firm's weighted average cost of capital (WACC) be if it makes this change in its capital structure? 11.4% 9.1% 8.0% 8.6%