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EFM-14problem

# EFM-14problem - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17...

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1 of 5 14problem 3/22/2010 7:10 11/10/2005 Chapter 14. Solution to End-of-Chapter Comprehensive/Spreadsheet Problem Problem 14-14 Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasury staff has consulted with investment bankers and, on the basis of those discussions, has created the following table showing its debt cost at different levels: Debt/Assets Equity/Assets Debt/Equity Bond B-T Cost of Ratio (D/E) Rating 0.0 1.0 0.00 A 7.00% 0.2 0.8 0.25 BBB 8.00% 0.4 0.6 0.67 BB 10.00% 0.6 0.4 1.50 C 12.00% 0.8 0.2 4.00 D 15.00% risk-free rate is 5 percent, the market risk premium is 6 percent, and its tax rate is 40 percent. a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structu Solution to Part a: Inputs provided in the problem: Risk-free rate 5% Market risk premium 6% Unlevered beta 1.2 Tax rate 40% Next, we construct a table (like that in the model) that evaluates WACC at different levels of debt. The beta is found using the Hamada equation:

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EFM-14problem - 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17...

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