WACC and Optimal Capital Structure F Pierce Products Inc is considering changing its capital structure F Pierce 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 Market Debt to Value Ratio (w d ) Market Equity to Value Ratio (w s ) Market Debt to Equity Ratio (D S) Before Tax Cost of Debt (r d ) 0 0 1 0 0 00 7 0 0 2 0 8 0 25 8 0 0 4 0 6 0 67 10 0 0 6 0 4 1 50 12 0 0 8 0 2 4 00 15 0 F Pierce uses the CAPM to estimate its cost of common equity, r s and at the time of the analaysis the risk free rate is 7 , the market risk premium is 5 , and the company's tax rate is 35 F Pierce estimates that its beta now (which is unlevered because it currently has no debt) is 0 8 Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure Do not round intermediate calculations Round your answers to two decimal places DEBT EQUITY WACC

The Answer is in the image, click to view ...

Answered step by step

Verified Expert Solution

Link Copied!

Question

1 Approved Answer

Posted on Oct 06, 2024

WACC and Optimal Capital Structure F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock,

WACC and Optimal Capital Structure

F. Pierce Products Inc. is considering changing its capital structure. F. Pierce 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:

Market Debt- to-Value Ratio (w_d)	Market Equity-to-Value Ratio (w_s)	Market Debt- to-Equity Ratio (D/S)	Before-Tax Cost of Debt (r_d)
0.0	1.0	0.00	7.0%
0.2	0.8	0.25	8.0
0.4	0.6	0.67	10.0
0.6	0.4	1.50	12.0
0.8	0.2	4.00	15.0

F. Pierce uses the CAPM to estimate its cost of common equity, r_s and at the time of the analaysis the risk-free rate is 7%, the market risk premium is 5%, and the company's tax rate is 35%. F. Pierce estimates that its beta now (which is "unlevered" because it currently has no debt) is 0.8. Based on this information, what is the firm's optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure? Do not round intermediate calculations. Round your answers to two decimal places.