Capital Structure Exercise

Estimate the optimal capital structure given the following information.

Current capital structure

Bond (semi-annual)

15 year maturity 6.5% coupon Price = $974 Maturity value = $1,000

Equity

(Rm Rf) = 5.4% 10 year government rate = 2.80%

Beta = .89

Wd = .4 We = .6

T = .34

Estimate the WACC at the existing capital structure and two alternative capital structures, one with 30% debt and one with 50% debt. Use the unlevered/levered beta technique to estimate the cost of equity for the alternatives. Adjust the cost of debt up or down by 1 percentage point to reflect differences in the risk of the alternatives.

Determine the optimal capital structure.