9. Determining the optimal capital structureAa AaUnderstanding the optimal capital structureReview this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc.has gathered the following financial information to help with the analysis.Debt Ratio Equity RatiordrsWACC30%70%7.00%10.50% 8.61%40%60%7.20%10.80% 8.21%50%50%7.70%11.40% 8.01%60%40%8.90%12.20% 8.08%70%30%10.30% 13.50% 8.38%Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure?Debt ratio =40%; equity ratio = 60%Debt ratio50%; equity ratio = 50%Debt ratio =70%; equity ratio30%Debt ratio =30%; equity ratio = 70%Debt ratio = 60%; equity ratio = 40%Consider this case:Globo-Chem Co. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 65%equity and 35% debt. The firm's cost of debt will be 8%, and it will face a tax rate of 40%. Consider this case:Globo-Chem Co. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 65%equity and 35% debt. The firm's cost of debt will be 8%, and it will face a tax rate of 40%.What will Globo-Chem Co.'s beta be if it decides to make this change in its capital structure?Now consider the case of another company:U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is8%, and its tax rate is 40%. It currently has a levered beta of 1.25. The risk-free rate is 3%, and the risk premiumon the market is 7.5%.U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firm'slevel of debt will cause its before-tax cost of debt to increase to 10%. Use the Hamada equation to unlever andrelever the beta for the new level of debt. What will the firm's weighted average cost of capital (WACC) be if it makesthis change in its capital structure?The optimal capital structure is the one thatthe WACC andthe firm's stock price.Higher debt levelsthe firm's risk. Consequently, higher levels of debt cause the firm's cost of equity toAxis Chemical Co. has found that its expected EPS is maximized at a debt ratio of 45%. Does this mean that AxisChemical Co.'s optimal capital structure calls for 45% debt?O YesO No

Aa Understanding the optimal capital structure Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio rd rs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? Debt ratio = 40%; equity ratio = 60% Debt ratio = 50%; equity ratio = 50% Debt ratio = 70%; equity ratio = 30% Debt ratio = 30%; equity ratio = 70% Debt ratio = 60%; equity ratio = 40% Consider this case:

Aa Understanding the optimal capital structure Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio rd rs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? Debt ratio = 40%; equity ratio = 60% Debt ratio = 50%; equity ratio = 50% Debt ratio = 70%; equity ratio = 30% Debt ratio = 30%; equity ratio = 70% Debt ratio = 60%; equity ratio = 40% Consider this case:

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter12: Valuation: Cash-flow Based Approaches

Section: Chapter Questions

Problem 12PC

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4. Determining the optimal capital structure 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 70% 60% 50% 40% 30% 30% 40% 50% 60% 70% Id Is WACC 7.00% 10.50% 8.61% 7.20% 10.80% 8.21% 7.70% 11.40% 8.01% 8.90% 12.20% 8.08% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Transworld Consortium Corp.'s optimal capital structure? Debt ratio = 60% ; equity ratio = 40% Debt ratio = 30%; equity ratio = 70% O Debt ratio = 40%; equity ratio = 60% O Debt ratio = 70% ; equity ratio = 30% O Debt ratio = 50% ; equity ratio = 50%
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 rdrd rsrs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Transworld Consortium Corp.’s optimal capital structure? Debt ratio = 70%; equity ratio = 30% Debt ratio = 40%; equity ratio = 60% Debt ratio = 30%; equity ratio = 70% Debt ratio = 50%; equity ratio = 50% Debt ratio = 60%; equity ratio = 40% Consider this case: Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 60% equity and 40% debt. The firm’s cost of debt will be 8%, and…
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 rdrd rsrs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Transworld Consortium Corp.’s optimal capital structure? Debt ratio = 70%; equity ratio = 30% Debt ratio = 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60% Debt ratio = 30%; equity ratio = 70% Debt ratio = 50%; equity ratio = 50% Consider this case: Globo-Chem Co. has a capital structure that consists of 30% debt and 70% equity. The firm’s current beta is 1.25, but management wants to understand Globo-Chem Co.’s market risk…
4. Determining the optimal capital structure 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% 70% 1.25 0.55 36.25 40% 60% 1.40 0.60 37.75 50% 50% 1.60 0.65 39.50 60% 40% 1.85 0.75 38.75 70% 30% 1.75 0.70 38.25 Which capital structure shown in the preceding table is Transworld Consortium Corp.’s optimal capital structure? Debt ratio = 30%; equity ratio = 70% Debt ratio = 40%; equity ratio = 60% Debt ratio = 50%; equity ratio = 50% Debt ratio = 60%; equity ratio = 40% Debt ratio = 70%; equity ratio = 30%
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 rdrd rsrs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Transworld Consortium Corp.’s optimal capital structure? Debt ratio = 70%; equity ratio = 30% Debt ratio = 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60% Debt ratio = 30%; equity ratio = 70% Debt ratio = 50%; equity ratio = 50% Consider this case: Globo-Chem Co. has a capital structure that consists of 30% debt and 70% equity. The firm’s current beta is 1.25, but management wants to understand Globo-Chem Co.’s market risk without the effect of leverage. If…
Review this situation: Transworld Consortium Corp. is trying to identify its optimal capital structure. Transworld Consortium Corp. has gathered following financial information to help with the analysis. Debt Ratio 30% 40% 50% 60% 70% Equity Ratio 70% 60% 50% 40% 30% WACC 9.71% 9.55% 10.02% 7.55% 11.30% 10.78% 8.24% 12.80% 11.45% rd Is 6.02% 9.40% 6.75% 9.750% 7.15% 10.60% Which capital structure shown in the preceding table is Transworld Consortium Corp.'s optimal capital structure? Debt ratio= 30%; equity ratio = 70% Debt ratio = Debt ratio = 70%; equity ratio = 30% Debt ratio= 50%; equity ratio = 50% 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60%
Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio rdrd rsrs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Universal Exports Inc.’s optimal capital structure? Debt ratio = 70%; equity ratio = 30% Debt ratio = 50%; equity ratio = 50% Debt ratio = 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60% Debt ratio = 30%; equity ratio = 70% Consider this case: Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 70% equity and 30% debt. The firm’s cost of debt will be 10%, and it will face a tax rate of 40%. What will Globex…
Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio rdrd rsrs WACC 30% 70% 7.00% 10.50% 8.61% 40% 60% 7.20% 10.80% 8.21% 50% 50% 7.70% 11.40% 8.01% 60% 40% 8.90% 12.20% 8.08% 70% 30% 10.30% 13.50% 8.38% Consider this case: Globex Corp. currently has a capital structure consisting of 35% debt and 65% equity. However, Globex Corp.’s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is 3%, the market risk premium is 7%, and Globex Corp.’s beta is 1.10. If the firm’s tax rate is 25%, what will be the beta of an all-equity firm if its operations were exactly the same? Now consider the case of another company: US Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%,…
Understanding the optimal capital structure Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio 30% 40% 50% 60% 70% Equity Ratio Consider this case: 70% 60% 50% 40% 30% Td Ts WACC 7.00% 10.50% 8.61% 7.20% 10.80% 8.21% 7.70% 11.40% 8.01% 8.90% 12.20% 8.08% 10.30% 13.50% 8.38% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? Debt ratio = 40% ; equity ratio = 60% Debt ratio = 30% ; equity ratio = 70% Debt ratio 50 % ; equity ratio = 50% Debt ratio 60%; equity ratio = 40% Debt ratio 70% ; equity ratio= 30%
Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio 30% 40% 50% 60% 70% Equity Ratio 70% 60% 50% 40% 30% Id 7.00% 7.20% 7.70% 11.40% 8.90% 12.20% 10.30% 13.50% Is WACC 10.50% 8.61% 10.80% 8.21% 8.01% 8.08% 8.38% Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? Debt ratio = 70%; equity ratio = 30% Debt ratio 50%; equity ratio = 50% Debt ratio = 30%; equity ratio = 70% Debt ratio = 40%; equity ratio = 60% Debt ratio= 60%; equity ratio = 40%
Please help solve and show work. eview this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio rdrd rsrs WACC 30% 70% 6.02% 9.40% 9.71% 40% 60% 6.75% 9.750% 9.55% 50% 50% 7.15% 10.60% 10.02% 60% 40% 7.55% 11.30% 10.78% 70% 30% 8.24% 12.80% 11.45% Which capital structure shown in the preceding table is Universal Exports Inc.’s optimal capital structure? Debt ratio = 70%; equity ratio = 30% Debt ratio = 30%; equity ratio = 70% Debt ratio = 50%; equity ratio = 50% Debt ratio = 60%; equity ratio = 40% Debt ratio = 40%; equity ratio = 60% Consider this case: Globex Corp. currently has a capital structure consisting of 35% debt and 65% equity. However, Globex Corp.’s CFO has suggested that the firm increase its debt ratio to 50%. The current risk-free rate is…
CALCULATING 3Ms COST OF CAPITAL In this chapter, we described how to estimate a companys WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining Manufacturings (MMM) WACC. 3. Next, we need to calculate MMMs cost of debt. We can use different approaches to estimate it. One approach is to take the companys interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in todays market (i.e., if MMMs outstanding bonds are trading at close to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the companys annual report by accessing the companys home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Remember that you need the after-tax cost of debt to calculate a firms WACC, so you will need MMMs tax rate (which has averaged around 30% in recent years). What is your estimate of MMMs after-tax cost of debt?