Question 1

Case I: Capital structure theory (no tax) Case II: Capital structure theory (corporate tax WACC : 10% EBIT: $40 million Debt-to-firm value(D/V): 60% Tax rate : 50% Cost of debt : 6% Unlevered cost of capital : 10% 1) In Case I, when the debt-to-firm value decreases from 60% to 50%, i) Figure out the new WACC. Does the capital structure affect WACC? (30points) 11) Figure out the new WACC. Does the capital structure affect the cost of equity? (30points) 2) In Case II, when the debt increases from S0 to $40mil., i) Figure out the unlevered firm's value. (30points) 11) Figure out the levered firm's value. (30points) 111 What is the optimal capital structure? In other words, does the capital structure affect the WACC? (30points)