Financial Management: Theory & Practice (MindTap Course List)
15th Edition
ISBN: 9781305632295
Author: Eugene F. Brigham, Michael C. Ehrhardt
Publisher: Cengage Learning
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Chapter 15, Problem 11P
Summary Introduction
To determine: Weighted average cost of capital and firm’s optimal capital structure
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B.F. Pierce & Company is considering changing its capital structure. The company currently has no
debt and no preferred stock, but it would like to add some debt to take advantage of low interest
rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under
various possible capital structures would be as follows:
9.21%
9.07%
8.83%
Market Debt-to-
Value Ratio
8.66%
(WD)
0.00
0.20
0.40
0.60
0.80
Market Equity-to-
Value Ratio
(WE)
1.00
0.80
0.60
0.40
0.20
Market Debt-to-
Equity Ratio
(D/E)
0.00
0.25
0.67
1.50
4.00
The company uses the CAPM to estimate its cost of common equity. Currently the risk-free rate is
5%, the market risk premium is 6%, and the company's tax rate is 35%. The company estimates
that its beta now (which is unlevered because it currently has no debt) is 0.8. Based on this
information, what is the firm's weighted average cost of capital at its optimal capital structure?
Before-Tax Cost of
Debt
(rD)
4.00%
6.00%
8.00%
10.00%
12.00%
F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currentlyhas no debt and no preferred stock, but it would like to add some debt to takeadvantage of low interest rates and the tax shield. Its investment banker has indicatedthat the pre-tax cost of debt under various possible capital structures would be asfollows:Market Debt-to-Value Ratio (wd)
0.0 0.2 0.4 0.6 0.8
Market Equity-to-Value Ratio (ws)
1.0
0.8
0.6
0.4
0.2
Market Debt-to-Equity Ratio (D/S)
0.00
0.25
0.67
1.50
4.00
Before-Tax Costof Debt (rd)
6.0%
7.0
8.0
9.0
10.0
F. Pierce uses the CAPM to estimate its cost of common equity, rs and at the time of theanalysis the risk-free rate is 5%, the market risk premium is 6%, and the company’s taxrate is 40%. F. Pierce estimates that its beta now (which is “unlevered” because itcurrently has no debt) is 0.8. Based on this information, what is the firm’s optimalcapital structure, and what would be the weighted average cost of capital at the optimalcapital…
B.F. Pierce & Company is considering changing its capital structure. The company currently
has no debt and no preferred stock, but it would like to add some debt to take advantage of
low interest rates and the tax shield. Its investment banker has indicated that the pre-tax
cost of debt under various possible capital structures would be as follows:
8.66%
9.21%
8.83%
Market Debt-to-
Value Ratio
9.07%
(WD)
0.00
0.20
0.40
0.60
0.80
Market Equity-to-
Value Ratio
(WE)
1.00
0.80
0.60
0.40
0.20
Market Debt-to-
Equity Ratio
(D/E)
0.00
0.25
0.67
1.50
4.00
Before-Tax Cost of
Debt
(rD)
5.00%
The company uses the CAPM to estimate its cost of common equity. Currently the risk-free
rate is 4%, the market risk premium is 6%, and the company's tax rate is 25%. The company
estimates that its beta now (which is unlevered because it currently has no debt) is 0.8.
Based on this information, what is the firm's weighted average cost of capital at its optimal
capital structure?
6.00%
7.00%
8.00%
9.00%
Chapter 15 Solutions
Financial Management: Theory & Practice (MindTap Course List)
Ch. 15 - Prob. 1QCh. 15 - What term refers to the uncertainty inherent in...Ch. 15 - Firms with relatively high nonfinancial fixed...Ch. 15 - “One type of leverage affects both EBIT and EPS....Ch. 15 - Why is the following statement true? Other things...Ch. 15 - Why do public utility companies usually have...Ch. 15 - Why is EBIT generally considered to be independent...Ch. 15 - If a firm went from zero debt to successively...Ch. 15 - Prob. 9QCh. 15 - Prob. 1P
Ch. 15 - Prob. 2PCh. 15 - Ethier Enterprise has an unlevered beta of 1.0....Ch. 15 - Nichols Corporations value of operations is equal...Ch. 15 - Lee Manufacturings value of operations is equal to...Ch. 15 - Dye Trucking raised $150 million in new debt and...Ch. 15 - Schweser Satellites Inc. produces satellite earth...Ch. 15 - Prob. 8PCh. 15 - Prob. 9PCh. 15 - Beckman Engineering and Associates (BEA) is...Ch. 15 - Prob. 11PCh. 15 - A. Fethe Inc. is a custom manufacturer of guitars,...Ch. 15 - Prob. 13SPCh. 15 - Prob. 1MCCh. 15 - Prob. 2MCCh. 15 - Prob. 4MCCh. 15 - Prob. 5MCCh. 15 - Prob. 6MCCh. 15 - Prob. 7MCCh. 15 - Prob. 10MCCh. 15 - Prob. 11MCCh. 15 - Prob. 12MC
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