Reference no: EM132740770

Question - From the topic of Cost Capital, Financial Leverage and Capital Structure

Problem 1 - Company Z has a bond issue outstanding that matures in fourteen years. The bonds pay interest semiannually. Currently, the bonds are quoted at 98 percent of face value and carry an 8 percent coupon. The firm's tax rate is 35 percent.

What is the firm's after-tax cost of debt?

Problem 2 - Medallion Cooling Systems, Inc., has total assets of P10,000,000, EBIT of P2,000,000, and preferred dividends of P200,000 and is taxed at a rate of 30%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:

Capital structure debt ratio Cost of debt, rd Number of common stock shares Required return, rs

0% 0% 200,000 12%

15% 8 170,000 13

30% 9 140,000 14

45% 12 110,000 16

60% 15 90,000 20

Choose the optimal capital structure. Justify your choice.