Please show all work...thank you LcCompte Learning Solutions is considering maki

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Please show all work...thank you

LcCompte Learning Solutions is considering making a change to its capital structure in hopes of increasing its value. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table: The company uses the CAPM to estimate its cost of common equity, rs The risk-free rate is 5% and the market risk premium is 6%. LcCompte estimates that if it had no debt its beta would be 1.0. (Its "unlevered beta," equals 1.0.) The company's tax rate, T, is 40%. On the basis of this information, what is LeCompte's optimal capital structure, and what is die firm's cost of capital at this optimal capital structure? lowest WACC)

Explanation / Answer

Levered Beta =Unlevered beta (1+ (1-t) (Debt/Equity))

Require retirn on equity = risk free rate + B* risk premium

WACC = After tax cost of debt* Debt%+ Cost of Equity*Equity %

Hence Optimal WACC is at Debt 40% and Equity 60%

Before tax cost After tax cost of debt Debt Equity Debt /Equity Cost of debt Levred Beta Return on Equity WACC 0.1 0.9 0.11 7% 4.20% 1.07 11.40% 10.68% 0.2 0.8 0.25 7.20% 4.32% 1.15 11.90% 10.38% 0.3 0.7 0.43 8% 4.80% 1.26 12.54% 10.22% 0.4 0.6 0.67 8.80% 5.28% 1.40 13.40% 10.15% 0.5 0.5 1.00 9.60% 5.76% 1.60 14.60% 10.18%

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