A clinic has obtained the following estimates for its costs of debt and equity a

ID: 2715542 • Letter: A

Question

A clinic has obtained the following estimates for its costs of debt and equity at various capital structures:

% Debt After-tax Cost of Debt Cost of Equity

0% -- 16%

20 7.0 17

40 8.5 18

60 10.0 20

70 13.0 24

What is the firm’s optimal capital structure?

Calculate its corporate cost of capital at each structure

The firm’s optimal capital structure is 60% Debt & 40% Equity in the given struture below

Corporate cost of capital at each structure :

0 % Debt

WACC = Cost of Equity

WACC = 16%

20 % Debt

WACC = Weight of Debt*After-tax Cost of Debt + (1-Weight of Debt)*Cost of Equity

WACC = 20%*7 + (1-20%)*17

WACC = 15%

40 % Debt

WACC = Weight of Debt*After-tax Cost of Debt + (1-Weight of Debt)*Cost of Equity

WACC = 40%*8.5 + (1-40%)*18

WACC = 14.20%

60 % Debt

WACC = Weight of Debt*After-tax Cost of Debt + (1-Weight of Debt)*Cost of Equity

WACC = 60%*10 + (1-60%)*20

WACC = 14.00%

70 % Debt

WACC = Weight of Debt*After-tax Cost of Debt + (1-Weight of Debt)*Cost of Equity

WACC = 70%*13 + (1-70%)*24

WACC = 16.30%

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