Optimal Capital Structure Assignment | Professional Writing

2. Naydenov Corporation is trying to determine its optimal capital structure. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. To estimate how much its debt would cost at different debt levels the company’s CFO has consulted with investment bankers and, on the basis of those discussions, has created the table on the following page. The firm currently has 20% debt and has 12,000 shares outstanding. It has no marketable securities. Once the optimal level of debt is determined, the firm will issue that amount of debt and use the proceeds to repurchase stock. The firm’s projected free cash flows are: Year Free cash flow ($ thousands) 10 15 20 Free cash flows are expected to grow at 3% after year 3.

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The firm’s current beta is 1.10; the risk-free rate is 4%, and the market risk premium is 7%. The firm’s tax rate is 21 percent. Data Summary: Growth rate of FCF after year 3 = 3% Current beta = 1.10 Current debt level = 20% Tax rate = 21% Shares outstanding (in thousands) =12.000 Risk-free rate = 4% Market risk premium – 7% a. Complete the following table for the 40% debt level. In the response box, indicate your values for each of the items (e.g., D/S = 0.250, rd(1-T) = 3.16%, etc) b. What is the optimal capital structure for the firm? Explain your decision b. What is the optimal capital structure for the firm? Explain your decision. ($values are in thousands, except stock price) # of decimal places Intrinsic value of equity Sprior Number of shares after repurchase % financed with debt Beta D/S 0.250 0.429 Value of operations $258.00 $261.50 (1-T) 3.16% 3.56% 20% Market value of debt $51.60 $78.45 Stock Price Pprior $17.20 $17.49 WACC 9.99% 9.90% 4.0% 4,5% 12.00 11.70% 12.61% 30% 1.23 10.47 40% 5.5% 50% 7.5% 1,00 5.93% 1.65 15.55% 10.74% $231.97 $115.99 $15.03 7.72

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