F. Pierce Products Inc. is considering changing its capitalstructure. F. Pierce currently has no debt and no preferred stock,but it would like to add some debt to take advantage of lowinterest rates and the tax shield. Its investment banker hasindicated that the pre-tax cost of debt under various possiblecapital structures would be as follows:
Market Debt-
to-Value
Ratio (wd) | Market Equity-to-Value
Ratio (ws) | Market Debt-
to-Equity
Ratio (D/S) | Before-Tax Cost of Debt(rd) |
| 0.0 | 1.0 | 0.00 | 7.0% | |
| 0.2 | 0.8 | 0.25 | 8.0 | |
| 0.4 | 0.6 | 0.67 | 10.0 | |
| 0.6 | 0.4 | 1.50 | 12.0 | |
| 0.8 | 0.2 | 4.00 | 15.0 | |
F. Pierce uses the CAPM to estimate its cost of common equity,rs and at the time of the analaysis the risk-free rateis 5%, the market risk premium is 8%, and the company's tax rate is40%. F. Pierce estimates that its beta now (which is "unlevered"because it currently has no debt) is 1.15. Based on thisinformation, what is the firm's optimal capital structure, and whatwould be the weighted average cost of capital at the optimalcapital structure? Do not round intermediate calculations. Roundyour answers to two decimal places.
