Ask Experts Questions for FREE Help!
 

Free Answers in 3 Easy Steps

Register Now
3 Steps
 


Ask QuestionsprogressAnswer QuestionsprogressBuild ReputationprogressBecome an Expert
 
At Ask Me Help Desk you can ask questions in any topic and have them answered for free by our experts. To ask questions or participate in answering them you must register for a free account. By registering you will be able to:
  • Get free answers from experts in any of our 300+ topics.
  • Accept money for answers that you provide.
  • Communicate privately with other members (PM).
  • See fewer ads.
  Answer this Question    Ask about Finance & Accounting    Ask about another Subject  
 

ktmf07
Feb 16, 2009, 08:43 AM
Hello, I had a question that I'm having trouble with in my finance class and was hoping for some direction. The question is as follows

A firm's current balance sheet is as follows:
Assets $100 Debt $10
Equity $90

a. What is the firm's weight average cost of capital at various combinations of debt and equity, given the following information?
Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12% ?
10 8 12 ?
20 8 12 ?
30 8 13 ?
40 9 14 ?
50 10 15 ?
60 12 16 ?

I was able to figure this out correctly I believe, I put the answers I got below

a. (0% x 8%) + (100% x 12%) = .120 or 12%
b. (0.10) x (0.08) + (0.90) x (0.12) = 0.116 or 11.6%
c. (0.2)(0.08) + (0.8)(0.12) = 0.112 or 11.2%
d. (0.3)(0.08) + (0.7)(0.13) = 0.115 or 11.5%
e. (0.4)(0.09) + (0.6)(0.14) = 0.120 or 12%
f. (0.5)(0.10) + (0.5)(0.15) = 0.125 or 12.5%
g. (0.6)(0.12) + (0.6)(0.16) = 0.136 or 13.6%

Cost of Capital
a.12%
b 11.6%
c 11.2%
d 11.5%
e 12%
f 12.5%
g 13.6%

I believe those are the answers but, the next part of the question asks me to do the following.
b. Construct a pro forma balance sheet that indicates the firm's optimal capital structure. Compare this balance sheet with the firms current balance sheet. What course of action should the firm take?
Assets $100 Debt $?
Equity $?

How exactly do I do this? Is there a formula for this and if so would someone be able to tell me what the formula is? I'm sorry I'm just slightly confused. Thank you anyone for your help.

ktmf07
Feb 16, 2009, 08:45 AM
Sorry everyone I guess the listed chart in the first part of the question didn't come out right but the numbers that go across correspond with the headings above...I was able to figure out that part though, I'm just unsure how to find the optimal capital structue of the Debt and Equity calculations and was wondering how to do them. Thank you.