Problem 21-05

Given the following, determine the firm’s optimal capitalstructure:
Debt/Assets   After-Tax Cost of Debt   Cost ofEquity
0   %   6   %  11   %
10       6      11  
20       7      11  
30       7      12  
40       9      14  
50       10      15  
60       12      16  
Round your answers for capital structure to the nearest wholenumber and for the cost of capital to one decimal place.

The optimal capital structure:
% debt and
% equity with a cost of capital of
%

If the firm were using 60 percent debt and 40 percent equity,what would that tell you about the firm’s use of financialleverage? Round your answer for the cost of capital to one decimalplace.
If the firm uses 60% debt financing, it would be using financialleverage. At that combination the cost of capital is
%. The firm could lower the cost of capital by substituting .

What two reasons explain why debt is cheaper than equity?
Debt is cheaper than equity because interest expense . In addition,equity investors bear risk.

If the firm were using 20 percent debt and 80 percent equity andearned a return of 9.5 percent on an investment, would this meanthat stockholders would receive less than their required return of11.0 percent?
If the firm earns 9.5% on an investment, the stockholders will earnthan their required 11.0%.

What return would stockholders receive? Round your answer to onedecimal place.

%