Question

will have a levered beta. Complete the tables below to help determine the optimal financing mix. No Debt | Low Debt Debt High Debt High Debt 1. What do yo what do you notice about the beta and cost of Weight of 1 equity as debt increases? What explains this? 1 0.8 0.2 equity weight of debt 0 0.2 10.8 0.21 tax rate 0.21 2. 0.21 What do you notice about the cost of debt as Unlevered Beta debt increases? What explains this? 1 1 Levered Beta Risk-Free MRP 2.16% 5.55% 2.16% 5.55% 2.16% 5.55% 3. What do you notice about the cost of capital as debt increases? What explains this? Cost of Equity No Debt Low Debt High Debt 4. What do you notice about the beta and cost of equity as debt increases? 1 0.8 0.2 0 0.2 0.2 0.8 weight of equity weight of debt cost of equity cost of debt tax rate 5. What do you notice about the cost of debt as debt increases? 6.00% 0 0.21 3.50% 0.21 0.21 6. What do you notice about the cost of capital as debt increases? WACC

Answer 1

ANS-

1. The beta and cost of equity increases as the level of debt increase. Because with high debt level, equity shareholders assumes more risk and they demand higher rate of return. That is the reason the beta and cost of equity is very high in case of higher debt levels.
2. Cost of debt increases as the level of debt increases, because as the debt is an obligation for the company. As debt increases other debt holders raises the required rate because they assume more risk with increase in level of debt.
3. The cost of capital i.e WACC(WEIGHTED AVERAGE COST OF CAPITAL) is lower at optimal level of debt. This is because company get tax shield for using optimal level of debt.Optimal capital structure is a point at which earning per share and value of firm is maximum and cost of capital is minimum.
4. SAME AS 1
5. SAME AS 2
6. SAME AS 3

Ans) Pat A KOebt Hgh low Debr No Obr Wughr Equity WeghDebt tox sale ০ এ। Unkuued Bete 7 levued Beto 1-1976 Ruk ace :16 2.16 2.16 MRP 5.55 CourGquity lt 8.80 25941 levued Bito Bula (Unlujud)1-to No Debt dow Debt 0.1976197 0.8 416 Cou 6quily RF +B[MaHRet rsk Peemum) Noadest - +1 55s 7-7 XDw debt ২5०५1- 4.16 fr) 2.16 t igh debt

Pans& WACC= NI Cequity Cor I-ta No 0ebt alow Debt 0& C8801) t D (35) Ci-0S1) 0.553 704 7-593 / 0-3 (ar584t) t 0-8 (600) (1-0-31 5 048 .t 371 7h Dest &-84.t