Nadir Inc. is an unlevered firm with constant operating earnings (EBIT) of $2 million per year. Nadir's tax rate is 40% and its market value is $12 million. Management is considering the use of some debt financing. (Debt would be used to buy back shares, so the size of the firm would remain constant.) The firm's analysts have estimated that the PV of any future financial distress costs is $8 million and that the probability of distress would increase with leverage according to the following table: Value of Debt $2,500,000 5,000,000 7,500,000 10,000,000 12,500,000 15,000,000 20,000,000 Probability of financial distress 0.00% 1.25% 2.50% 6.25% 12.50% 31.25% 75.00% a) What is Nadir's cost of equity and the WACC at this time? b) According to M&M's Case II, what is Nadir's optimal level of debt? c) What is the optimal capital structure when financial distress costs are included

Answer rating: 100% (QA)

To solve this problem we need to follow these steps a Calculating Nadirs cost of equity and WACC Nadir is an unlevered firm so its cost of equity is e... View the full answer