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Question 1 Capital Structure Assume that you have just been hired as business manager of Cheetah Cafe (CC), which is located adjacent to the campus of University Putra Malaysia. Sales were $1,100,000 last year, variable costs were 60% of sales and fixed costs were $40,000. Therefore, EBIT totaled $400,000. Because the university's enrollment is capped, EBIT is expected to be constant over time. Because no expansion capital is required, CC distributes all earnings as dividends. Invested capital is $2 million, and 80,000 shares are outstanding. The management group owns about 50% of the stock, which is traded in the over-the-counter market. CC currently has no debtit is an all-equity firmand its 80,000 shares outstanding sell at a price of $25 per share, which is also the book value. The firm's corporate tax rate is 40%. On the basis of statements made in your finance text, you believe that CC's shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion. In today's market the risk-free rate, r RE, is 6% and the market risk premium. RPM_ is 6%. CC's unlevered beta, b LL is 1.0. CC currently has no debt, so its cost of equity (and WACC) is 12%. If the firm was recapitalized, debt would be issued and the borrowed funds would be used to repurchase stock. Stockholders, in turn, would use funds provided by the repurchase to buy equities in other companies similar to CC. You plan to complete your report by asking and then answering the following questions. d. After speaking with a local investment banker, you obtain the following estimates of the cost of debt at different debt levels in thousands of dollars): rd Amount Borrowed $ Debt/Capital Ratio Bond Rating Debt/Equity Ratio 0 0.000 0.0000 250 0.125 0.1429 AA 8.0% 500 0.250 0.3333 A 9.0 750 0.375 0.6000 BBB 11.5 1,000 0.500 1.0000 BB 14.0 1) Now consider the optimal capital structure for CC. define the terms optimal capital structure and target capital structure? 2) Why does CC's bond rating and cost of debt depend on the amount of money borrowed? 3) Is EPS maximized at the debt level that maximizes share price? Why or why not