Optimal Capital Structure

Q No. 1

Percent financed with debt

DEBT

RATE

0 0.10.1 0.10.2 0.1050.3 0.110.4 0.120.5 0.140.6 0.16

Operating profit of firm is Rs. 80,000 and tax rate is 40%. Risk free rate is 10%, market premium is 6% and unlevered beta is 1.

Required:

Calculate at what level of debt firm will maximized value.

Q No.2

ICI company has unlevered beta of 1.2. Risk free rate in market is 11.5% and investor required 6% risk premium to invest in market. Tax rate of company is 35%. Following is the schedule of borrowing rate obtained from bank for different level of debt level in capital structure. Firm anticipating Rs. 120,000 operating profit(EBIT).

DEBT RATE00.1 0.10.2 0.1050.3 0.110.4 0.120.5 0.140.6 0.16

Calculate debt level in capital structure where firm obtained maximum value. Use Hamada equation and show complete schedule to obtained firm value at different level of debt.

Q No.3

Lucky Cement company has unlevered beta of 1. Risk free rate in market is 9% and investor required 5% risk premium to invest in market. Tax rate of company is 35%. Following is the schedule of borrowing rate obtained from bank for different level of debt level in capital structure. Firm anticipating Rs. 200,000 operating profit(EBIT).

DEBT RATE00.1 0.10.2 0.1050.3 0.110.35 0.120.45 0.140.55 0.16

Calculate debt level in capital structure where firm obtained maximum value. Use Hamada equation and show complete schedule to obtained firm value at different level of debt.