The Tech Hardware Company is trying to estimate its optimal capital structure. Tech’s current capital structure consists of 20% debt and 80% equity; however, management believes the firm should use more debt. The risk-free rate is 1.3%, the market risk premium is 6%, and the firm’s tax rate is 35%. Currently, Tech’s cost of equity is 16%, which is determined on the basis of the CAPM.
a. Determine Tech’s current beta.
b. What would be Tech’s unlevered beta?
c. If Tech were to change its capital structure from its current one so to have its assets and operations finance with 45% debt, determine its beta under this new capital structure.
d. Determine Tech’s new cost of equity under the new capital structure with 45% debt.
e. If the cost of debt were 6%, what would be Tech’s weighted average cost of capital under the new capital structure with 45% debt?
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