WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital… 1 answer below »


WACC AND OPTIMAL CAPITAL

STRUCTURE Elliott Athletics is involved to designate its optimal high erection, which now consists of solely default and dishonorable equity. The solid does not currently use preferred supply in its high erection, and it does not scheme to do so in the forthcoming. Its stock staff has consulted after a while boarding bankers. On the foundation of those discussions, the staff has created the subjoined consultation showing the solid’s default consume at contrariant levels:

Debt-to-

Assets Ratio

(wd)

Equity-to-

Assets Ratio

(wc)

Debt-to-Equity

Ratio (D/E)

Bond

Rating

Before-Tax

Cost of

Debt (rd)

0.0

1.0

0.00

A

7.0%

0.2

0.8

0.25

BBB

8.0

0.4

0.6

0.67

BB

10.0

0.6

0.4

1.50

C

12.0

0.8

0.2

4.00

D

15.0

Elliott uses the CAPM to value its consume of dishonorable equity, rs, and values that the endangerfree admonish is 5%, the chaffer endanger bounty is 6%, and its tax admonish is 40%. Elliott values that if it had no default, its “unlevered” beta, bU, would be 1.2.

a. What is the solid’s optimal high erection, and what would be its WACC at the optimal high erection?

b. If Elliott’s managers forecast that the company’s interest endanger obtain extension in the forthcoming, what result would this likely own on the solid’s target high erection?

c. If Congress were to dramatically extension the corpoadmonish tax admonish, what result would this likely own on Elliott’s target high erection?

d. Plot a graph of the after-tax consume of default, the consume of equity, and the WACC versus (1) the default/assets proportion and (2) the default/equity proportion.