FI 516 FM12 Ch 16 P13 Build a Model

# FI 516 FM12 Ch 16 P13 Build a Model - 1/31/2007 Chapter 16....

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1 of 4 1/31/2007 Chapter 16. Solution to Ch 16-13 Build a Model Market Market Market Debt/Value Equity/Value Debt/Equity Debt B-T Cost of Ratio (D/S) Rating 0 1 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% 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: the WACC. 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. To estimate how much its debt would cost at different debt levels, the company's Treasury staff has consulted with investment bankers and, on the basis of those discussions, has created the following table: Ratio (w d ) Ratio (w ce ) Debt (r d ) Elliott uses the CAPM to estimate its cost of common equity, r s . The company estimates that the risk-free

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## This note was uploaded on 03/05/2011 for the course FI 516 taught by Professor Cole during the Fall '10 term at Keller Graduate School of Management.

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FI 516 FM12 Ch 16 P13 Build a Model - 1/31/2007 Chapter 16....

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