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ACB Inc. is examining its capital structure with the intent of arriving at an optimal debt ratio. It currently has no debt and has a beta of 1.3. The T-bill rate is 8% and the T-Bond rate is 9.5%. Your research indicates that the debt rating will as follows at different debt levels:
D/(D+E) Rating Interest rate
0% AAA 10%
10% AA 10.5%
20% A 11%
30% BBB 12%
40% BB 13%
50% B 14%
60% CCC 16%
70% CC 18%
80% C 20%
90% D 25%
The firm currently has 2 million shares outstanding at $30 per share. (Tax rate = 40%)
a. What is the firm's optimal debt ratio?
b. Assuming that the firm restructure and purchases stock with debt, what will the value pf the stock be after the restructuring?
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