Bigbee Company currently has no debt; it is 100% equity

Bigbee Company currently has no debt; it is 100% equity financed. With its current capital structure, the stock’s beta is 1.5. The company is looking to take on some debt to buy back some stock, but management is unsure of how much debt to issue. You have been asked to calculate the optimal capital structure.

The company is experiencing zero growth, and that will continue for the foreseeable future; therefore, there is no immediate need to retain any earnings. All of its earnings are given out in dividends. The company’s tax rat is 40%. The risk free rate is 6% and the market risk premium is 4%.

Investment Bankers have determined that the company would owe the following yield to maturity rates given various capital structures: For the same capital structure scenarios, the company has calculated expected EPS 0% debt 10% debt 20% debt 30% debt 40% debt 50% debt 60% debt 0% 8% 8.3% 9.0% 10% 12% 15% 0% debt 10% debt 20% debt 30% debt 40% debt 50% debt 60% debt $2.40 $2.56 $2.75 $2.97 $3.20 $3.36 $3.30


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