9. Determining the optimal capital structure

Understanding the optimal capital structure

Review this situation: Transworld Consortium Corp. is trying to identify its optimal capital structure. Transworld Consortium Corp. has gathered the following financial information to help with the analysis.

Debt Ratio	Equity Ratio	EPS	DPS	Stock Price
30%	70%	1.25	0.55	36.25
40%	60%	1.40	0.60	37.75
50%	50%	1.60	0.65	39.50
60%	40%	1.85	0.75	38.75
70%	30%	1.75	0.70	38.25

Which capital structure shown in the preceding table is Transworld Consortium Corp.s optimal capital structure? Pick one answer below

A) Debt ratio = 50%; equity ratio = 50%

B) Debt ratio = 40%; equity ratio = 60%

C) Debt ratio = 70%; equity ratio = 30%

D) Debt ratio = 30%; equity ratio = 70%

E) Debt ratio = 60%; equity ratio = 40%

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Consider this case:

Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 65% equity and 35% debt. The firms cost of debt will be 6%, and it will face a tax rate of 35%.

What will Globex Corp.s beta be if it decides to make this change in its capital structure? Pick one answer: 1.82 / 1.76 / 1.62 / 1.35

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Now consider the case of another company:

U.S. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 6%, and its tax rate is 35%. It currently has a levered beta of 1.10. The risk-free rate is 2.5%, and the risk premium on the market is 7%.

U.S. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firms level of debt will cause its before-tax cost of debt to increase to 8%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firms weighted average cost of capital (WACC) be if it makes this change in its capital structure?

(Hint: Do not round intermediate calculations.) __________ Pick one answer: 8.9% / 9.8% / 7.6% / 8.5%

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Which of the following statements regarding a firms optimal capital structure are true? Check all that apply.

I ) The optimal capital structure minimizes the firms WACC.

II) The optimal capital structure minimizes the firms cost of equity.

III) The optimal capital structure maximizes the firms stock price.

IV) The optimal capital structure maximizes the firms EPS.

V) The optimal capital structure minimizes the firms cost of debt.

Please answer all the questions! Thank you again.