Use the following information to answer questions 6-10. All I Got, Inc. (NYSE: AIG) is considering changing its capital structure. AIG currently has no debt and no preferred stock, but it would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows:

AIG uses the CAPM to estimate its cost of common equity, rs, and at the time of the analysis the risk-free rate is 5%, the market risk premium is 6%, and the companys tax rate is 40%. AIG estimates that its beta now (which is unlevered because it currently has no debt) is 1.0.

6. What is the cost of common equity for the capital structure of 40% debt and 60% equity?

7. What is the cost of common equity for the capital structure of 60% debt and 40% equity?

8. What is the WACC for the capital structure of 20% debt and 80% equity?

9. What is the WACC for the capital structure of 80% debt and 20% equity?

10. What is the firms optimal capital structure?

a.)Debt = 80%; Equity = 20% b.)Debt = 60%; Equity = 40% c.)Debt = 40%; Equity = 60% b.)Debt = 20%; Equity = 80% e.)Debt = 0%; Equity = 100%

\begin{tabular}{ccc} \hline MarketDebt-to-ValueRatio(wd) & MarketEquity-to-ValueRatio(ws) & Before-TaxCostofDebt(rd) \\ \hline 0.0 & 1.0 & 6.0% \\ 0.2 & 0.8 & 7.0% \\ 0.4 & 0.6 & 8.0% \\ 0.6 & 0.4 & 9.0% \\ 0.8 & 0.2 & 10.0% \\ \hline \end{tabular}