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Washington Paper Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure as follows:
Debt Ratio [B/(B + E)] Pretax Cost of Debt (kd) Cost of Equity (ke)
0.00 - 14.0%
0.10 7.0% 14.2
0.20 7.2 14.6
0.30 7.6 15.4
0.40 8.2 17.0
0.50 9.0 20.0
0.60 10.0 26.0
The firm's marginal (and average) income tax rate is 40 percent. Determine the company's optimal capital structure.
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