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    Optimal capital structure

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    The CEO needs you to calculate the company's weighted-average cost of capital (WACC). In addition to calculating the WACC, the CEO wants you to explain how the capital structure would need to change if the firm wanted to reduce its cost of capital. The CEO believes the company needs a split of 25% debt to 75% equity to have an optimal capital structure, and she also wants you to explain if the capital structure is optimal now. If it is not, would moving to an optimal capital structure increase or decrease the cost of capital?

    From your previous work, you know the following facts:
    * Company debt and other long-term obligations are US$14 million. The split for the US$14 million is US$5 million in bonds that are at 8% and US$9 million in a long-term loan at 7.5%
    * Company equity is US$150.1 million.
    * Cost equity (according to SML) is 9%.
    * The company is in the 40% tax bracket.

    Given the above information, you will determine the WACC and explain the other information Kim needs

    I need help with the math.

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    Solution Preview

    The weighted average cost of capital of the firm, on the basis of given information =
    (150.1/164.1)*9 + (8/164.1)*5*0.6 + (9/164.1)*9*0.6 = 8.63% (approx.)
    Under the Net Income approach, optimal capital structure is one wherein 100% debt capital is employed in the ...

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