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Changing WACC and optimal choice. Austin Enterprises is
currently an all-equity firm. The firm is considering selling debt
(bonds) and retiring some of the equity. However, at each level of
debt, debt becomes more expensive (cost of debt is rising), and the
riskiness of the equity also rises with more and more debt. Using a
spreadsheet, determine the best combination of debt and equity for
Austin Enterprises if
· The current beta of Austin Enterprises is 0.85.
· The current market return is 12%.
· The current risk-free rate is 3%.
· The total equity is 20,000,000 shares at $25 per share.
· Debt is sold in units of $2,000,000.
· The first unit of debt has a cost of 7.5%.
· The tax rate of Austin Enterprises is 40%.
·
For each additional unit of debt (each additional $2,000,000),
the cost of debt rises by 0.85%, and the beta of Austin Enterprises
rises by 0.025.
Where is the WACC the lowest? Graph the results of the changing
WACC
Chapter 12 Problem 17
Working capital and capital budgeting. Farbuck’s Tea Shops is
thinking about opening another tea shop. The incremental cash flow
for the first five years is as follows: