Question

Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis. Debt Ratio Equity Ratio 30% 70% Stock Price 36.25 37.75 40% 60% EPS 1.25 1.40 1.60 1.85 1.75 DPS 0.55 0.60 0.65 0.75 0.70 50% 50% 39.50 60% 40% 38.75 70% 30% 38.25 Which capital structure shown in the preceding table is Universal Exports Inc.'s optimal capital structure? O Debt ratio = 40%; equity ratio = 60% O Debt ratio = 30%, equity ratio = 70% Debt ratio = 60%; equity ratio = 40% Debt ratio = 50%; equity ratio = 50% O Debt ratio = 70%; equity ratio = 30% Consider this case: Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capital structure to 60% equity and 40% debt. The firm's cost of debt will be 8%, and it will face a tax rate of 45%.

Answer 1

1)Review this situation: Universal Exports Inc. is trying to identify its optimal capital structure. Universal Exports Inc. has gathered the following financial information to help with the analysis
Debt Ratio 50% and Equity Ratio 50%	Correct
The optimal capital structure is the financing mix of debt and equity that balances a firm’s risk and expected return and maximizes long-run shareholder wealth. The capital structure that maximizes the stock price also maximizes shareholder wealth. Both Universal Exports Inc.’s earnings per share (EPS) and dividends per share (DPS) are maximized at a debt ratio of 60%, but that is not the same as maximizing long-run shareholder wealth. The firm’s optimal capital structure occurs at a debt ratio of 50%, which results in the highest stock price.
Globex Corp. is an all-equity firm, and it has a beta of 1. It is considering changing its capitalstructure to 60% equity and 40% debt. The firm's cost of debt will be 6%, and it will face a tax rateof 45%.What will Globex Corp.'s beta be if it decides to make this change in its capital structure?
Levered beta = Unlevered beta * [1 + (1 - Tax rate) * (Debt / Equity)]
Levered beta =1 * [1 + (1 - 45%) * (40%/ 60%)]	1.03