Explain why shareholders benefit when wacc is minimized

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Reference no: EM131308894

Problem -

Firm has consulted with investment bankers and determined the interest rate it would pay for different capital structures, as shown below. Data for the risk-free rate, the market risk premium, an estimate of firm's unlevered beta, and the tax rate are also shown below. Based on this information, what is the firm's optimal capital structure and what is the weighted average cost of capital at the optimal structure?

Percent Financed with Debt (w_d)	Before-tax Cost Debt (rd)



0%	6.0%
10%	6.1%
20%	7.0%
30%	8.0%
40%	10.0%
50%	12.5%
60%	15.5%
70%	18.0%

Input Data
Risk-free rate	4.5%
Market risk premium	5.5%
Unlevered beta	0.8
Tax rate	40.0%

Fill in formulas in the cells to find the optimum capital structure.

Debt/Value	Equity/Value	Debt/Equity	A-T Cost of	Levered	Cost of
Ratio (w_d)	Ratio (w_s)	Ratio (w_d/w_s)	Debt (r_d)	Beta	Equity	WACC
0%	1.0	0.00
10%	0.9	0.11
20%	0.8	0.25
30%	0.7	0.43
40%	0.6	0.67
50%	0.5	1.00
60%	0.4	1.50
70%	0.3	2.33

Explain how the cost of debt AND the cost of stock are a function of the level of debt of a company.

Explain why shareholders benefit when WACC is minimized.

Discuss any other concerns managers might face when setting capital structure.

Attachment:- Assignment.rar

Reference no: EM131308894

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