Question
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Situational Software Co. (SSC) is trying to establish its optimal capital structure. Its current capital structure...
Situational Software Co. (SSC) is trying to establish its optimal capital structure. Its current capital structure consists of 40% debt and 60% equity; however, the CEO believes that the firm should use more debt. The risk-free rate, rRF, is 5%; the market risk premium, RPM, is 6%; and the firm's tax rate is 40%. Currently, SSC's cost of equity is 15%, which is determined by the CAPM. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below.
Open spreadsheet
| Hamada equation | |||
| Original % debt in capital structure, wd | 40.00% | ||
| Original % common equity in capital structure, wc | 60.00% | ||
| Risk-free rate, rRF | 5.00% | ||
| Market risk premium, RPM | 6.00% | ||
| Tax rate, T | 40.00% | ||
| Firm's cost of equity, rs | 15.00% | ||
| Formulas | |||
| Calculation of firm's current beta: | |||
| Firm's current beta, bL | #N/A | ||
| Calculation of firm's unlevered beta: | |||
| Firm's unlevered beta, bU | #N/A | ||
| New % of debt in capital structure, wd New | 50.00% | ||
| New % of common equity in capital structure, wc New | 50.00% | ||
| Calculation of firm's new beta: | |||
| Firm's new beta, bL New | #N/A | ||
| Calculation of firm's new cost of equity: | |||
| Firm's new cost of equity, rs New | #N/A | ||
What would be SSC's estimated cost of equity if it changed its capital structure to 50% debt and 50% equity? Round your answer to two decimal places. Do not round intermediate steps.
%
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Situational Software Co. (SSC) is trying to establish its
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Currently, SSC's cost of equity is 12%, which is determined by the
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HAMADA EQUATION Situational Software Co. (SSC) is trying to establish its optimal capital structure. Its current...
HAMADA EQUATION
Situational Software Co. (SSC) is trying to establish its
optimal capital structure. Its current capital structure consists
of 20% debt and 80% equity; however, the CEO believes that the firm
should use more debt. The risk-free rate, rRF, is 3%;
the market risk premium, RPM, is 7%; and the firm's tax
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Equity-to-total-
Debt-to-equity
Bond B-T cost
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0.10
0.90
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0.80
0.20/0.80 =
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Debt-to-total- Equity-to-total- Debt-to-equity Bond B-T
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(wd) assets
ratio
(wc) ratio
(D/E) rating of
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0.10 0.90 0.10/0.90
=
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0.20 0.80 0.20/0.80
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1.84
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Which capital structure shown in the preceding table is
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identify its optimal capital structure. Transworld Consortium Corp.
has gathered the following financial information to help with the
analysis.
Debt Ratio
Equity Ratio
EPS
DPS
Stock Price
30%
70%
1.55
0.34
22.35
40%
60%
1.67
0.45
24.56
50%
50%
1.72
0.51
25.78
60%
40%
1.78
0.57
27.75
70%
30%
1.84
0.62
26.42
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a.
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b.
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c.
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d.
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