{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Capital structure practice solution(1)

5 is the levered beta at the de ratio of 025 200m

Info iconThis preview shows page 4. Sign up to view the full content.

View Full Document Right Arrow Icon
The stock beta of 1.5 is the levered beta at the D/E ratio of 0.25 ($200m/ $800m). Using the levered beta formula, the unlevered beta can be calculated as 1.277 d) What will be the levered betas at the debt ratio of 20%, 30%, and 40%? Calculate the corresponding cost of equity using CAPM. (5 points) Using the unlevered beta calculated above and the levered beta formula, we can calculate @20% debt ratio, the levered beta is 1.5; @30% debt ratio, the levered beta is 1.66; @40% debt ratio, the levered beta is 1.87. Using the CAPM formula, we can calculate the cost of equity @20 debt ratio, Ke = 11.5%; @30 debt ratio, Ke = 12.3%; @40 debt ratio, Ke = 13.35%; e) Calculate the WACC under the three debt ratios? Which debt ratio will you choose to maximize firm value? (5 points) Use the WACC formula (there is no preferred stock here) @20% debt ratio, WACC = 0.2*4.30%*(1-0.3) + 0.8*11.5% = 9.80% @30% debt ratio, WACC = 0.3*4.63%*(1-0.3) + 0.7*12.3% = 9.58% @40% debt ratio, WACC = 0.4*4.84%*(1-0.3) + 0.6*13.35% = 9.37% Therefore, we should choose the 40% debt ratio to maximize firm value.
Background image of page 4
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}