close solutoin list

WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm dots not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasure staff consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firms debt cost at different debt levels: Elliott uses the CAPM to estimate its cost of common equity, r d and estimates that the risk free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott estimates that if it had no debt, its “unlevered” beta, b ut would be 1.2. a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structure? b. If Elliott's managers anticipate that the company's business risk will increase in the future, what effect would this likely have on the firm's target capital structure? c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott's target capital structure? d. Plot a graph of the after-tax cost of debt, the cost of equity, and the WACC versus (1) e. the debt/capital ratio and (2) the debt /equity ratio.

BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250
BuyFind

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
Publisher: Cengage Learning
ISBN: 9781337395250

Solutions

Chapter
Section
Chapter 14, Problem 14SP
Textbook Problem

WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm dots not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasure staff consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firms debt cost at different debt levels:

Chapter 14, Problem 14SP, WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital

Elliott uses the CAPM to estimate its cost of common equity, rd and estimates that the risk free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott estimates that if it had no debt, its “unlevered” beta, but would be 1.2.

  1. a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structure?
  2. b. If Elliott's managers anticipate that the company's business risk will increase in the future, what effect would this likely have on the firm's target capital structure?
  3. c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott's target capital structure?
  4. d. Plot a graph of the after-tax cost of debt, the cost of equity, and the WACC versus (1)
  5. e. the debt/capital ratio and (2) the debt /equity ratio.

Expert Solution

Want to see this answer and more?

Experts are waiting 24/7 to provide step-by-step solutions in as fast as 30 minutes!*

See Solution

*Response times vary by subject and question complexity. Median response time is 34 minutes and may be longer for new subjects.

Chapter 14 Solutions

Fundamentals of Financial Management (MindTap Course List)
Show fewer chapter solutions
Ch. 14 - Changes in sales cause changes in profits. Would...Ch. 14 - Would each of the following increase, decrease, or...Ch. 14 - Discuss the following statement: All else equal,...Ch. 14 - If Congress increased the personal tax rate on...Ch. 14 - Which of the following would likely entourage, a...Ch. 14 - Why do public utilities generally use different...Ch. 14 - Why is EBIT generally considered independent of...Ch. 14 - Is the dept level that maximizes a firms expected...Ch. 14 - If a firm goes from zero dept to successively...Ch. 14 - When the Bell System was broken up, the old ATT...Ch. 14 - A firm is about to double its assets to serve its...Ch. 14 - BREAK-EVEN ANALYSIS A company's fixed operating...Ch. 14 - OPTIMAL CAPITAL STRUCTURE Terrell Trucking Company...Ch. 14 - RISK ANALYSIS a. Given the following information,...Ch. 14 - UNLEVERED BETA Hartman Motor has. 18 million in...Ch. 14 - FINANCIAL LEVERAGE EFFECTS Firms HL and LL are...Ch. 14 - BREAK EVEN ANALYSIS The Warren Watch Company sells...Ch. 14 - FINANCIAL LEVERAGE EFFECTS The Neal Company wants...Ch. 14 - HAMADA EQUATION Situational Software Co. (SSC) is...Ch. 14 - RECAPITALIZATION Tartan industries currently has...Ch. 14 - BREAKEVEN AND OPERATING LEVERAGE a. Given the...Ch. 14 - RECAPITALIZATION Currently, Forever Flowers Inc....Ch. 14 - BREAKEVEN AND LEVERAGE Wingler Communications...Ch. 14 - FINANCING ALTERNATIVES The Severn Company plans to...Ch. 14 - WACC AND OPTIMAL CAPITAL STRUCTURE Elliott...Ch. 14 - Exploring the Capital Structures for Four...Ch. 14 - Exploring the Capital Structures for Four...

Additional Business Textbook Solutions

Find more solutions based on key concepts
Show solutions
Give three examples of important trade-offs that you face in your life.

Brief Principles of Macroeconomics (MindTap Course List)

How are inflation and unemployment related in the short run?

Essentials of Economics (MindTap Course List)

What is the purpose of a work sheet?

College Accounting (Book Only): A Career Approach

Define (a) sensitivity analysis, (b) scenario analysis, and (c) simulation analysis. If GE were considering two...

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)

What steps are followed in posting from the cash payments journal to the general ledger?

College Accounting, Chapters 1-27 (New in Accounting from Heintz and Parry)