Find out the macro consequences of a reduction, Financial Management

Angel Athletics is trying to determine its optimal capital structure. The company's capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:

Percent financed          Percent financed                      Debt-to-equity             Bond          Before-tax

With debt (wd)              with equity (wE)                     ratio (D/E)                    rating        Credit Spread


0.10                                    0.90                            0.10/0.90 = 0.11            AAA                 0.7%

0.20                                    0.80                            0.20/0.80 = 0.25             AA                   1.0%

0.30                                    0.70                            0.30/0.70 = 0.43               A                    1.4%

0.40                                    0.60                            0.40/0.60 = 0.67            BBB                 2.2%

0.50                                    0.50                            0.50/0.50 = 1.00            BB+                  3.4%

0.70                                    0.30                            0.70/0.30 = 2.33            BB-                  6.6%

0.90                                    0.20                            0.90/0.10 = 9.00               B                    10.8%

The company's tax rate, τ, is 50 percent. The company uses the CAPM to estimate its cost of common equity, re. The risk-free rate is 4% and the market risk premium is 6%. Angel estimates that if it had no debt its beta would be 1.0. (Its "unlevered beta," βU, equals 1.0.) The levered beta, β, relates to the unlevered beta, βU, via β = [1 + (1 - τ)*D/E] βU

A.  On the basis of this information, whereby WACC is minimized?

B.  If the tax rate is reduced to 10.1%, whereby WACC is minimized?

Based on your findings, then, argue what are the macro consequences of a reduction of corporate tax rate from 50.01% to 10.01%?

Posted Date: 3/21/2013 2:16:47 AM | Location : United States

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