ABC Manufacturing Co. has a total capitalization of 1,00,00,000 and normally earns Tk. 10,00,000 (before interest and taxes). The financial manager of the firm wants to take a decision regarding the capital structure. After study of the capital market, he collected the following data: 

Amount of debt (In Taka) Interest Rate (%) Equity Capitalization Rate (At this level of financial risk) (%) 

- - 10.00 

10,00,000 4.0 10.50 

20,00,000 4.0 11.00 

30,00,000 4.5 11.60 

40,00,000 5.0 12.40 

50,00,000 5.5 13.50 

60,00,000 6.0 16.00 

70,00,000 8.0 20.00 

Required: 

a) What amount of debt should be employed if the traditional approach is held valid? 

b) If the MM approach is followed, what should be the equity capitalization rates? Assume that corporate taxes do not exist and the firm maintains its capital structure at book value.

Answer rating: 100% (QA)

Quiz a The traditional approach to capital structure suggest... View the full answer