Understanding the optimal capital structure Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? Debt ratio =50%; equity ratio =50% Debt ratio =70%; equity ratio =30% Debt ratio =60%; equity ratio =40% Debt ratio =40%; equity ratio =60% Globo-Chem Co. currently has a capital structure consisting of 35% debt and 65% equity. However, Globo-Chem Co.'s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 2.5%, the market risk premium is 8%, and GloboChem Co.'s beta is 1.10. If the firm's tax rate is 45%, 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 6%, and its tax rate is 45%. It currently has a levered beta of 1.10. The risk-free rate is 2.5%, and the risk premium on the market is 8%. 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 cost of debt to increase to 8%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firm's weighted average cost of capital (WACC) be if it makes this change in its capital structure? (Hint: Do not round intermediate calculations.) The optimal capital structure is the one that the WACC and the firm's stock price. Higher debt levels the firm's risk. Consequently, higher levels of debt cause the firm's cost of equity to As an analyst, Olivia is comparing two nearly identical manufacturing firms: Green Rabbit Manufacturing Company and Purple Tiger Production Inc. It is your job to evaluate the relative business and financial risks of Green Rabbit and Purple The two firms have the same level of total assets and expected net operating profit after taxes (NOPAT), but they differ in two critical characteristics: total debt and the standard deviation of the expected NOPAT. The following table outlines some of Green Rabbit's and Purple Tiger's major attributes: Use the given financial data to indicate which firm has the higher degree of each type of risk. Which firm has more business risk? Purple Tiger Green Rabbit Which firm has more financial risk? Purple Tiger Green Rabbit