Question

1.      Lucian Leasing is being formed to acquire a package of leases that will generate $42 million of before tax cashflows each year for the next 99 years. (For practical purposes, you can treat this as an infinite series of cash flows.) The cost of buying the leases is $150,000,000. The firm is considering various amounts of debt financing, as given in the following table:

Total Amount of                                Average Yield                                   Common

Debt Raised                                       on Debt                                              Stock beta

0                                                          -                                             0.50

$ 25,000,000                                                  12.0%                                     0.60

50,000,000                                                     13.0                                        0.75

75,000,000                                                     14.0                                        1.00

100,000,000                                                   16.0                                        1.40

125,000,000                                                   20.0                                        2.00

The risk free rate is 10%, and the expected return on the market is 18%. The tax rate is 50%.

For each level of debt, compute the weighted average cost of capital and the total value of the firm. What is the optimal capital structure?