Optimal capital structure

Reference no: EM1350776

10. (This problem combines material from Chapters 21 and 22.) The financial manager has determined the following schedules for the cost of funds:

Cost of Debt Ratio Cost of Debt Equity
0% 5% 13%
10 5 13
20 5 13
30 5 13
40 5 14
50 6 15
60 8 16

a. Determine the firm's optimal capital structure.

b. Construct a simple pro forma balance sheet that shows the firm's optimal combination of debt and equity for its current level of assets.
Assets $500 Debt â?"
Equity â?"
$500

c. An investment costs $400 and offers annual cash inflows of $133 for five years. Should the firm make the investment?

d. If the firm makes this additional investment, how should its balance sheet appear?
Asset â?" Debt â?"
Equity â?"

e. If the firm is operating with its optimal capital structure and a $400 asset yields 20.0 percent, what return will the stockholders earn on their investment in the asset?

Reference no: EM1350776

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