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B E G H K D F The following firm has an expected EBIT of $1,000,000, they currently have no debt, their tax rate is 40%, and they have 100,000 shares outstanding. They are trying to determine an optimal capital structure 3 because they plan on issuing debt and buying back common stock (Note that the total size of the firm will not change, we are replacing equity with debt). The company pays all of their Net Income out as dividends and has a 0% growth rate (The expected EBIT of $1,000,000 is going to be the same forever.) You have been given esimates of their Cost of Debt and Cost of Equity at different levels of debt Note that the debt will be issued at par so that the Cost of Debt is also the Coupon Rate on the debt. It is your goal to determine the optimal capital structure for the firm Risk Free Rate 0.03 1 Unlevered Risk 0.07 Risk Multiplier 1.03 3 EBIT = 1,000,000 Tax Rate = 30% Debt Rd Re Net Inc Equity Value Firm Value % Debt 0 3.00% 7.00% 700,000 10,000,000 10,000,000 0.00% 500,000 3.18% 7 22% 688,860 9,544,429 10,044,429 4.98% 1,000,000 3.38% 7.44% 676,361 9,088,683 10,088,683 9.91% 1,500,000 3.58% 7.67% 662,376 8,632.105 10,132,105 14.80% 2,000,000 3.80% 7.91% 646,769 8,174,026 10,174,026 19.66% 2,500,000 4,03% 8.16% 629,389 7.713,767 10,213,767 24.48% 3,000,000 428% 8.41% 610,075 7.250,633 10 250,633 29 27% 3,500,000 4.54% 8.68% 588,652 6.783,917 10,283,917 34.03% 4,000,000 4.82% 8.95% 564,929 6,312,895 10,312,895 38.79% 4,500,000 5 12% 923% 538,698 5,836,823 10,336,823 43.53% 5,000,000 5.44% 9.52% 509,735 5,354,940 10,354,940 48.29% 5,500,000 5.77% 9.82% 477,7954,866,461 10,366,461 53.06% 6,000,000 6.13% 10.13% 442,613 4,370,579 10,370,579 57 86% 6,500,000 6.51% 10.45% 403,901 3,866,461 10,366,461 62.70% 7,000,000 6.91% 10.78% 361,345 3,353,243 10,353,243 67.61% 7,500,000 7.34% 11.12% 314,604 2,830,034 10,330.034 72.60% Leverage OptCapStr Sheet3 Share Shares WACC Price Outstanding 7.00% 100.00 100,000 6.97% 100.44 95,022 6.94% 100.89 90,088 6.91% 101.32 85,196 6.88% 101.74 80,342 6 85% 10214 75,523 6.83% 10251 70,734 6.81% 102.84 65,966 6.79% 103.13 61,214 6.77% 103.37 56,466 6.76% 103.55 51,714 6.75% 103.66 46,944 6.75% 103.71 42,144 6.75% 103.66 37,298 6.76% 103.53 32,388 6.78% 103.30 27,396 4 ca A M M. AAA AC AR dy 223 G K 3 5 6 7 8 9 0 1 2 3 14 5 16 37 38 39 30 1 42 43 14 45 46 47 48 49 A 4,000,000 4,500,000 5,000,000 5,500,000 6,000,000 6,500,000 7,000,000 7,500,000 8,000,000 8,500,000 9,000,000 9,500,000 10,000,000 10,500,000 11,000,000 11,500,000 B D E F G 4.82% 8.95% 564,929 6,312,895 10,312,895 38.79% 5.12% 923% 538,698 5,836,823 10,336,823 43.53% 5.44% 9.52% 509,735 5,354,940 10,354,940 48 29% 5.77% 9.82% 477,795 4,866,461 10,366,461 53.06% 6.13% 10.13% 442,613 4,370,579 10,370,579 57 86% 6.51% 10.45% 403,901 3,866,461 10,366,461 62.70% 6.91% 10.78% 361,345 3,353,243 10,353,243 67.61% 7.34% 11.12% 314,604 2,830,034 10,330,034 72.60% 7 80% 11.47% 263,307 2.295,905 10,295,905 77.70% 8.28% 11.83% 207,051 1.749,893 10,249,893 8293% 8.80% 12 21% 145,396 1,190,991 10,190,991 88 31% 9.36% 12 60% 77,865 618,149 10.118,149 93.89% 9.94% 13.00% 3,934 30,270 10,030 270 99.70% 10.57% 13.41% -76,963 -573,801 9,926,199 105.78% 11.24% 13.84% -165,449 -1,195,273 9,804,727 112. 19% 11 95% 14.29% 262,201 -1,835,424 9,664,576 118.99% H 6.79% 103.13 6.77% 103.37 6.76% 103.55 6.75% 103.66 6.75% 103.71 6.75% 103.66 6.76% 103 53 6.78% 103.30 6.80% 102.96 6.83% 102.50 6.87% 101.91 6.92% 101.18 6.98% 100,30 7.05% 99 26 7.14% 98.05 7 24% 96.65 61,214 56,466 51,714 46,944 42,144 37,298 32,388 27,396 22,299 17,072 11,687 6,109 302 -5,781 -12, 191 18.991 Assets 2E+06 EBIT = 400,000 Tax Rate = 40% Debt Kd Net Inc Equity Value Firm Value % Debt 0 6.00% 12.00% 280,000 2,333,333 2,333,333 0.00% 250,000 8.00% 12.51% 266,000 2,125,571 2,375,571 12 50% 500,000 9.00% 13.20% 248,500 1,882,576 2,382,576 25.00% 750,000 11.50% 14.16% 219,625 1,551,024 2,301,024 37.50% 1,000,000 14.00% 15.60% 182,000 1,166,667 2,166,667 50.00% Share Shares WACC Price Outstandir EPS 12.00% 29.17 80,000 3.5 11.55% 29.76 71,429 3.724 11.25% 29.95 62,857 3.953 11.44% 28.57 54.286 4.046 1200% 25.52 45,714 3.981 For questions 6-10, use the OptCapStr tab of the Optimal Capital Structure spreadsheet posted on Moodle. Assume a tax Rate of 30% and an EBIT of 1,000,000 unless stated otherwise. 10. Assume the Risk Free Rate is 3.5%, the Unlevered Risk is 7%, and the Risk Multiplier is 1.025. What level of debt minimizes the WACC if the tax rate is 20%? a) 500,000 b) 1,500,000 c) 2,500,000 d) 3,500,000 B E G H K D F The following firm has an expected EBIT of $1,000,000, they currently have no debt, their tax rate is 40%, and they have 100,000 shares outstanding. They are trying to determine an optimal capital structure 3 because they plan on issuing debt and buying back common stock (Note that the total size of the firm will not change, we are replacing equity with debt). The company pays all of their Net Income out as dividends and has a 0% growth rate (The expected EBIT of $1,000,000 is going to be the same forever.) You have been given esimates of their Cost of Debt and Cost of Equity at different levels of debt Note that the debt will be issued at par so that the Cost of Debt is also the Coupon Rate on the debt. It is your goal to determine the optimal capital structure for the firm Risk Free Rate 0.03 1 Unlevered Risk 0.07 Risk Multiplier 1.03 3 EBIT = 1,000,000 Tax Rate = 30% Debt Rd Re Net Inc Equity Value Firm Value % Debt 0 3.00% 7.00% 700,000 10,000,000 10,000,000 0.00% 500,000 3.18% 7 22% 688,860 9,544,429 10,044,429 4.98% 1,000,000 3.38% 7.44% 676,361 9,088,683 10,088,683 9.91% 1,500,000 3.58% 7.67% 662,376 8,632.105 10,132,105 14.80% 2,000,000 3.80% 7.91% 646,769 8,174,026 10,174,026 19.66% 2,500,000 4,03% 8.16% 629,389 7.713,767 10,213,767 24.48% 3,000,000 428% 8.41% 610,075 7.250,633 10 250,633 29 27% 3,500,000 4.54% 8.68% 588,652 6.783,917 10,283,917 34.03% 4,000,000 4.82% 8.95% 564,929 6,312,895 10,312,895 38.79% 4,500,000 5 12% 923% 538,698 5,836,823 10,336,823 43.53% 5,000,000 5.44% 9.52% 509,735 5,354,940 10,354,940 48.29% 5,500,000 5.77% 9.82% 477,7954,866,461 10,366,461 53.06% 6,000,000 6.13% 10.13% 442,613 4,370,579 10,370,579 57 86% 6,500,000 6.51% 10.45% 403,901 3,866,461 10,366,461 62.70% 7,000,000 6.91% 10.78% 361,345 3,353,243 10,353,243 67.61% 7,500,000 7.34% 11.12% 314,604 2,830,034 10,330.034 72.60% Leverage OptCapStr Sheet3 Share Shares WACC Price Outstanding 7.00% 100.00 100,000 6.97% 100.44 95,022 6.94% 100.89 90,088 6.91% 101.32 85,196 6.88% 101.74 80,342 6 85% 10214 75,523 6.83% 10251 70,734 6.81% 102.84 65,966 6.79% 103.13 61,214 6.77% 103.37 56,466 6.76% 103.55 51,714 6.75% 103.66 46,944 6.75% 103.71 42,144 6.75% 103.66 37,298 6.76% 103.53 32,388 6.78% 103.30 27,396 4 ca A M M. AAA AC AR dy 223 G K 3 5 6 7 8 9 0 1 2 3 14 5 16 37 38 39 30 1 42 43 14 45 46 47 48 49 A 4,000,000 4,500,000 5,000,000 5,500,000 6,000,000 6,500,000 7,000,000 7,500,000 8,000,000 8,500,000 9,000,000 9,500,000 10,000,000 10,500,000 11,000,000 11,500,000 B D E F G 4.82% 8.95% 564,929 6,312,895 10,312,895 38.79% 5.12% 923% 538,698 5,836,823 10,336,823 43.53% 5.44% 9.52% 509,735 5,354,940 10,354,940 48 29% 5.77% 9.82% 477,795 4,866,461 10,366,461 53.06% 6.13% 10.13% 442,613 4,370,579 10,370,579 57 86% 6.51% 10.45% 403,901 3,866,461 10,366,461 62.70% 6.91% 10.78% 361,345 3,353,243 10,353,243 67.61% 7.34% 11.12% 314,604 2,830,034 10,330,034 72.60% 7 80% 11.47% 263,307 2.295,905 10,295,905 77.70% 8.28% 11.83% 207,051 1.749,893 10,249,893 8293% 8.80% 12 21% 145,396 1,190,991 10,190,991 88 31% 9.36% 12 60% 77,865 618,149 10.118,149 93.89% 9.94% 13.00% 3,934 30,270 10,030 270 99.70% 10.57% 13.41% -76,963 -573,801 9,926,199 105.78% 11.24% 13.84% -165,449 -1,195,273 9,804,727 112. 19% 11 95% 14.29% 262,201 -1,835,424 9,664,576 118.99% H 6.79% 103.13 6.77% 103.37 6.76% 103.55 6.75% 103.66 6.75% 103.71 6.75% 103.66 6.76% 103 53 6.78% 103.30 6.80% 102.96 6.83% 102.50 6.87% 101.91 6.92% 101.18 6.98% 100,30 7.05% 99 26 7.14% 98.05 7 24% 96.65 61,214 56,466 51,714 46,944 42,144 37,298 32,388 27,396 22,299 17,072 11,687 6,109 302 -5,781 -12, 191 18.991 Assets 2E+06 EBIT = 400,000 Tax Rate = 40% Debt Kd Net Inc Equity Value Firm Value % Debt 0 6.00% 12.00% 280,000 2,333,333 2,333,333 0.00% 250,000 8.00% 12.51% 266,000 2,125,571 2,375,571 12 50% 500,000 9.00% 13.20% 248,500 1,882,576 2,382,576 25.00% 750,000 11.50% 14.16% 219,625 1,551,024 2,301,024 37.50% 1,000,000 14.00% 15.60% 182,000 1,166,667 2,166,667 50.00% Share Shares WACC Price Outstandir EPS 12.00% 29.17 80,000 3.5 11.55% 29.76 71,429 3.724 11.25% 29.95 62,857 3.953 11.44% 28.57 54.286 4.046 1200% 25.52 45,714 3.981 For questions 6-10, use the OptCapStr tab of the Optimal Capital Structure spreadsheet posted on Moodle. Assume a tax Rate of 30% and an EBIT of 1,000,000 unless stated otherwise. 10. Assume the Risk Free Rate is 3.5%, the Unlevered Risk is 7%, and the Risk Multiplier is 1.025. What level of debt minimizes the WACC if the tax rate is 20%? a) 500,000 b) 1,500,000 c) 2,500,000 d) 3,500,000

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