Start with the partial model in the file Ch16 P12 Build a Model.xls on the textb

Question

Start with the partial model in the file Ch16 P12 Build a Model.xls on the textbook?s Web site. Reacher Technology has consulted with bankers and determined the interest rate it would pay for different capital structures, as shown in the following table. Data for the risk-free rate, the market risk premium, an estimate of Reacher?s unlevered beta, and the tax rate are also shown. Based on this information, what is the firm's optiomal capital structure, and what is the weighted average cost of capital at the optimal structure?

Explanation / Answer

levered beta = unlevered beta * (1 +D/E)

after tax cost of debt = before tax cost of debt * (1 - tax rate)

cost of equity = risk free rate * levered beta * market risk premium

WACC = wd(rd)(1 – T) + wc(rs)

optimal capital structure is 20 % debt 80% equity at which the WACC is lowest

Risk free rate 4.50% Market risk premium 5.50% Unlevered beta 0.8 Tax rate 40% Wd We =(1 - Wd) D/E Before tax cost of debt After tax cost of debt Levered beta cost of equity WACC 0% 100% 0 6% 3.60% 0.8 8.900% 8.900% 10% 90% 0.111111 6.10% 3.66% 0.888889 9.389% 8.816% 20% 80% 0.25 7% 4.20% 1 10.000% 8.840% 30% 70% 0.428571 8% 4.80% 1.142857 10.786% 8.990% 40% 60% 0.666667 10% 6.00% 1.333333 11.833% 9.500% 50% 50% 1 12.50% 7.50% 1.6 13.300% 10.400% 60% 40% 1.5 15.50% 9.30% 2 15.500% 11.780% 70% 30% 2.333333 18% 10.80% 2.666667 19.167% 13.310%

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