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Determining Optimal Capital Structure

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Determining Optimal Structure
SBC Corp. Has capital structure of 30% debt and 70% equity. The firm current Beta is 1.25, but management wants to understand SBC market risk without effect of leverage. If SBC corp. has a 45% tax rate, what is the unlevered beta.,

A. 0.86
B. 0.96
C. 1.11
D. 1.01
DOM company has current capital structure of 30% debt 70% equity. Current before tax cost of debt is 10% and its tax rate is 45% . Currently has a levered beta of 1.25. The risk free rate is 3.5% and the risk premium on the market is 7.5%
DOM is considering changing its capital structure to 60% debt and 40% equity. Increasing the firms level of debt will cause its before tax cost of debt to increase to 12%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firms WACC be if it makes the change in its capital structure.
a. 6.5%
b. 7.6%
c.8.7%
d.10.9%

Which Capital Structure is the Optimal Capital Structure
Debt ratio-30% equity 70% EPS 1.25 DPS 0.55 Stock price 36.25
Debt ratio -40% equity 60% EPS 1.40 DPS 0.60 stock price 37.75
Debt ratio -50% equity 50% EPS 1.60 DPS 0.65 stock price 39.50
Debt ratio- 60% equity 40% EPS 1.85 DPS 0.75 Stock price 38.75
Debt ratio 70% equity 30% EPS 1.75 DPS 0.70 stock price 38.25
a. Debt Ration = 50% Equity Ratio = 50%
b. Debt Ratio= 40% equity Ratio= 60%
c. Debt Ratio= 70% Equity Ratio= 30%
d. Debt Ratio= 30% Equity Ratio= 70%
e. Debt Ratio= 60% Equity Ratio= 40%

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Solution Preview

Hi,

Get the answer with the attachment.

Answer:
Given that,
Debt =30%
Equity=70%
Current beta (levered beta) =1.25
Tax rate =45%
Therefore,
Unlevered beta=1.25/(1+((1-45%)*(30%)/(70%)) )=1.01

Given that,
Current ...

Solution Summary

The expert determines the optimal capital structures. The effect of leverage for a market risk is provided.

$2.19
See Also This Related BrainMass Solution

No Leverage, Inc., and High Leverage, Inc: Determine Optimal Capital Structure

Two firms, No Leverage, Inc., and High Leverage, Inc, have equal levels of operating risk and differ only in their capital structure. No Leverage is unlevered and High Leverage has $500,00 of perpetual debt in its capital structure. Assume that the perpetual annual income of both firms available for stockholders is paid out as dividends. Hence, the growth rate for both firms is zero. The income tax rate for both firms is 40 percent. Assume that there are no financial distress costs or agency costs. Given the following data:

No Leverage Inc High Leverage Inc

Equity in capital structure $1,000,000 $500,000
Cost of equity Ke 10% 13%
Debt in capital structure - $500,000
Pretax cost of debt, Kd - 7%
Net operating income (EBIT) $100,000 $100,000

determine the:

a. Market value of No Leverage, Inc
b. Market value of High Leverage, Inc
c. Present value of the tax shield to High Leverage Inc.

Jersey Computer Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure:

Proportion of debt After tax cost Debt Ki Cost of Equity Ke

0.00 - 12.0%
0.10 4.7% 12.1%
0.20 4.9% 12.5%
0.30 5.1% 13.0%
0.40 5.5% 13.9%
0.50 6.1% 15.0%
0.60 7.5% 17.0%

a. Determine the firm's optimal capital structure, assuming a marginal income tax rate (T) of 40 percent.

b. Suppose that the firm's current capital structure consists of 30 percent debt (and 70 percent equity). How much higher is its weighted cost of capital than at the optimal capital structure?

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