9. Determining the optimal capital structure As Aa Understanding the optimal cap
ID: 2771351 • Letter: 9
Question
9. Determining the optimal capital structure As Aa Understanding the optimal capital structure Review this situation: Transworld Consortium Corp. is trying to identify its optimal capital structure. Transworld Consortium Corp. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio EPS DPS Stock Price 30% 40% 50% 60% 70% 70%1.55 0.34 22.35 60% : 1.67 0.45 24.56 50% 1.72 0.51 25.78 40% , 1.78 0.57 27.75 30% 1.84 0.62 26.42 Which capital structure shown in the preceding table is Transworld Consortium Corp.'s optimal capital structure? Debt ratio-30%; equity ratio 70% o Debt ratio-S0%; equity ratio-50% Debt ratio-60%; equity ratio 40% Debt ratio = 70%; equity ratio 30% Debt ratio = 40%; equity ratio 60% Consider this case: Globex Corp. has a capital structure that consists of 30% debt and 70% equity. The firm's current beta 1s 1.15, but management wants to understand Globex Corp.'s market risk without the effect of leverage. tf Globex Corp. has a 35% tax rate, what is its unlevered beta? INS FIOExplanation / Answer
Answer-1:
Optimal Capital structure is that Debt Equity ratio at which the shareholder’s wealth is maximized , or say the market price of share is maximum.
At Debt 60% Equity 40%, the Market price is Maximum 27.75
Hence Debt 60% Equity 40%, is the optimal Capital Structure.
Answer-2:
Calculation of Unlevered Beta:
Unlevered Beta = Levered Beta / (1 + ((1 – Tax Rate) x (Debt/Equity)))
= 1.15 / (1 + ((1 – 35%) x (30/70)))
= 1.15 / (1 + ((0.65) x (0.42857)))
= 1.15 / (1 + 0.27857)
= 0.90
Hence Unlevered Beta is 0.90
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