Flashtronics is trying to determine its optimal capital structure. The company’s capital structure consists of debt...

80.2K

Verified Solution

Question

Finance

Flashtronics is trying to determine its optimal capitalstructure. The company’s capital structure consists of debt andcommon stock.  In order to estimate the cost of debt, thecompany has produced the following table:
Debt-to-total-              Equity-to-total-               Debt-to-equity           Bond      B-Tcost
assets ratio(w_d)           assetsratio(w_c)               ratio(D/E)                rating      ofdebt

0.10                            0.90                      0.10/0.90=0.11         AA              6.0%
0.20                            0.80                      0.20/0.80=0.25           A               6.6
0.30                            0.70                      0.30/0.70=0.43           A               7.3
0.40                            0.60                      0.40/0.60=0.67          BB              7.9
0.50                            0.50                      0.50/0.50=1.00           B               8.7
The company’s tax rate is 35 percent.
The company currently has a D/E ratio of 20% and uses the CAPMto estimate its cost of common equity,k_s.  The risk-free rate is 4.5 percent and themarket risk premium is 6 percent. Flashtronics’ current beta is1.3.
On the basis of this information, what is Flashtronics’ optimalcapital structure, and what is the firm’s weighted average cost ofcapital (WACC) at this optimal capital structure?You must show theWACC to two decimal places at each debt level.

Answer & Explanation Solved by verified expert

3.9 Ratings (509 Votes)

Optimum capital structure is the point where the weighted average cost of capital WACC is the minimum We have got 5 scenarios here and we will calculate WACC for each of them The WACC See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member

Transcribed Image Text

Flashtronics is trying to determine its optimal capitalstructure. The company’s capital structure consists of debt andcommon stock. In order to estimate the cost of debt, thecompany has produced the following table:Debt-to-total- Equity-to-total- Debt-to-equity Bond B-Tcostassets ratio(wd) assetsratio(wc) ratio(D/E) rating ofdebt 0.10 0.90 0.10/0.90=0.11 AA 6.0%0.20 0.80 0.20/0.80=0.25 A 6.60.30 0.70 0.30/0.70=0.43 A 7.30.40 0.60 0.40/0.60=0.67 BB 7.90.50 0.50 0.50/0.50=1.00 B 8.7The company’s tax rate is 35 percent.The company currently has a D/E ratio of 20% and uses the CAPMto estimate its cost of common equity,ks. The risk-free rate is 4.5 percent and themarket risk premium is 6 percent. Flashtronics’ current beta is1.3.On the basis of this information, what is Flashtronics’ optimalcapital structure, and what is the firm’s weighted average cost ofcapital (WACC) at this optimal capital structure?You must show theWACC to two decimal places at each debt level.