Information Science Inc. has consulted with investment bankers and determined the interest rate it would pay for different capital...

 

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Information Science Inc. has consulted with investment bankers and determined the interest rate it would pay for different capital structures, as shown below. Data for the risk-free rate, the market risk premium, an estimate of Information Science's unlevered beta, and the tax rate are also shown below. Percent Financed with Debt (wa) 0% 10% 20% 30% 40% 50% 60% 70% Before-tax Cost Debt (rd) 5.0% 5.5% 6.0% 6.75% 9.0% 12.5% 14.5% 16.0% Input Data Risk-free rate Market risk premium Unlevered beta Tax rate 3.5% 7.5% 0.8 40.0% The company currently has no debt. The expected free cash flow is $45 million. Capex equates to current depreciation, and there is no change in net operating working capital. The company expects zero growth. The company has no short-term investments, and it has 10 million shares outstanding. Q1. Based on the above information, what is the firm's optimal capital structure and what is the weighted average cost of capital at the optimal structure? Use excel spreadsheet to show all workings and result in a presentable manner. (30) Q2. Assume that the company decides to raise debt in accordance with the determined optimal capital structure above. In addition, assume that the company uses the cash raised from the debt to repurchase shares. Create a table (excel) that will show the anatomy of a recapitalization from the base position (no debt) to after debt but before share repurchase, and finally after the repurchase. The table must show, at a minimum, the value of operations, value of equity, price per share and total shareholder wealth. (25) Q3. Write a brief conclusion of the key takeaways from this analysis (one to two pages - double spacing). (25) Q4. Given the coverage of capital structure in this class, together with having completed the above analysis for Information Science Inc., do you feel that there is an optimal capital structure. Defend your answer. (20)

Answer rating: 100% (QA)