La Camorra currently uses no debt financing (i.e. total capital equals total equity) but is considering a
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La Camorra currently uses no debt financing (i.e. total capital equals total equity) but is considering a recapitalization to change its capital structure by issuing new debt and using the proceeds to buy back shares of common stock. You are given the following information about the firm, including the cost of debt (RD) at various levels of potential leverage (WD). Complete Table 2 below.
Table 1
| Unlevered Beta | 1.1 | ||||
| Risk-Free Rate | 3.40% | ||||
| Market Risk Premium | 7% | ||||
| Tax Rate | 34% | ||||
| Total Invested Capital | $1,200,000 | ||||
| Current # of Shares Outstanding | 135,000 | ||||
| Current Stock Price | $23.55 | ||||
| Initial Free Cash Flow (FCF0) | $250,000 | ||||
| FCF Constant Growth Rate | 3% |
|
Table 2 | |||||
| Weight of Debt (WD) | 0% | 10% | 25% | 40% | 50% |
| Cost of Debt (RD) | 0.00% | 5.40% | 5.60% | 6.80% | 8.40% |
| Weight of Equity (WE) | |||||
| Levered Beta | |||||
| Cost of Equity (RE) | |||||
| WACC | |||||
| Firm Value | |||||
| Debt Value | |||||
| Equity Value | |||||
| New # of Shares | |||||
| New Price per Share |
a.What is the optimal capital structure (i.e. optimal level of debt)? How can you tell?
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