B.C. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its...
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B.C. Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before-tax cost of debt is 10%, and its tax rate is 40%. It currently has a levered beta of 1.10. The risk-free rate is 2.5%, and the risk premium on the market is 8%.
B.C. Robotics Inc. is considering changing its capital structure to 60% debt and 40% equity. Increasing the firms level of debt will cause its before-tax cost of debt to increase to 12%. Use the Hamada equation to unlever and relever the beta for the new level of debt. What will the firms weighted average cost of capital (WACC) be if it makes this change in its capital structure? (Note: In calculating the companys cost of equity, you are to use the CAPM cost of equity equation.)
The optimal capital structure is the one that (maximizes/minimizes) the WACC and (maximizes/minimizes) the firms stock price. Higher debt levels (increase/decrease) the firms risk. Consequently, higher levels of debt cause the firms cost of equity to (increase/decrease) .
Axis Chemical Co. has found that its expected EPS is maximized at a debt ratio of 45%. Does this mean that Axis Chemical Co.s optimal capital structure calls for 45% debt? No/Yes
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