(This problem combines material from Chapters 21 and 22.) Thefinancial manager h

Question

(This problem combines material from Chapters 21 and 22.) Thefinancial manager has
determined the following schedules for the cost of funds:

Cost of DebtRatio                          Cost ofDebt                         Equity
0%            5%                              13%
10                                                            5                                  13
20                                                            5    13
30                                                            5    13
40                                                            5                                  14
50                                                            6                                  15
60          8                                  16

a. Determine the firm's optimal capital structure.
b. Construct a simple pro forma balance sheet that shows the firm'soptimal combination of
debt and equity for its current level of assets.
Assets $500     Debt              —
                             Equity            —
                                                  $500
c. An investment costs $400 and offers annual cash inflows of $133for five years. Should
the firm make the investment?
d. If the firm makes this additional investment, how should itsbalance sheet appear?
Asset   —       Debt   —
                            Equity —
e. If the firm is operating with its optimal capital structure anda $400 asset yields 20.0
percent, what return will the stockholders earn on their investmentin the asset?

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