Reacher Technology has consulted with investment bankers and

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Chapter 15. Ch 15-12 Build a Model

Reacher Technology has consulted with investment bankers and determined the interest rate it would pay for different capital structures, as shown below. Data for the risk-free rate, the market risk premium, an estimate of Reacher's unlevered beta, and the tax rate are also shown below. Based on this information, what is the firm's optimal capital structure and what is the weighted average cost of capital at the optimal structure?

Percent Financed with Debt (wd) Before-tax Cost Debt (rd) Input Data
Risk-free rate 4.5%
Market risk premium 5.5%
Unlevered beta 0.8
0% 6.0% Tax rate 40.0%
10% 6.1%
20% 7.0%
30% 8.0%
40% 10.0%
50% 12.5%
60% 15.5%
70% 18.0%

Fill in formulas in the yellow cells to find the optimum capital structure.

Debt/Value Equity/Value Debt/Equity A-T Cost of Levered Cost of
Ratio (wd) Ratio (ws) Ratio (wd/ws) Debt (rd) Beta Equity WACC
0% 1.0 0.00
10% 0.9 0.11
20% 0.8 0.25
30% 0.7 0.43
40% 0.6 0.67
50% 0.5 1.00
60% 0.4 1.50
70% 0.3 2.33

WACC at optimum debt ratio =
Optimum debt ratio =

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Solution Summary

Reacher Technology has consulted with investment bankers and determined the interest rate it would pay for different capital structures, as shown below. Data for the risk-free rate, the market risk premium, an estimate of Reacher's unlevered beta, and the tax rate are also shown below. Based on this information, what is the firm's optimal capital structure and what is the weighted average cost of capital at the optimal structure?

Percent Financed with Debt (wd) Before-tax Cost Debt (rd) Input Data
Risk-free rate 4.5%
Market risk premium 5.5%
Unlevered beta 0.8
0% 6.0% Tax rate 40.0%
10% 6.1%
20% 7.0%
30% 8.0%
40% 10.0%
50% 12.5%
60% 15.5%
70% 18.0%

Fill in formulas in the yellow cells to find the optimum capital structure.

Debt/Value Equity/Value Debt/Equity A-T Cost of Levered Cost of
Ratio (wd) Ratio (ws) Ratio (wd/ws) Debt (rd) Beta Equity WACC
0% 1.0 0.00
10% 0.9 0.11
20% 0.8 0.25
30% 0.7 0.43
40% 0.6 0.67
50% 0.5 1.00
60% 0.4 1.50
70% 0.3 2.33

WACC at optimum debt ratio =
Optimum debt ratio =