Problem
Holding Company is trying to determine its optimal capital structure. The firm's investment bankers have provided the following information about the cost of borrowing at different levels of debt. Holding uses CAPM to estimate its cost of equity. The company estimates that the market risk premium is 8% and the risk free rate is 5% The firm's corporate tax rate is 40%. If the firm had no debt, the beta of the equity would be 1.1
Based on this information and the information in th etable below identify the company's optimal capital structure. Complete the table. Show all calculations and explain why you selected this option.
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Debt-to-Value Ratio
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Equity -to Value Ratio
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Cost of Debt
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Cost of Equity
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WACC
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|
0
|
1
|
6.0
|
|
|
|
0.2
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0.8
|
7.5
|
|
|
|
0.5
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0.5
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9.0
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|
|
|
0.7
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0.3
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12.0
|
|
|