Assume that your firm is considering the following capital structure alternatives: all equity, 75% equity, 50% equity and 25% equity. They estimate that under those scenarios, their bond rating would be AA, A, BBB, and BB respectively and their before-tax cost of debt would be 5%, 6%, 8.5% and 11% respectively. Based on this information and the values you have researched/calculated previously for total capital, operating income, risk-free rate, market risk premium, implied tax rate, shares outstanding and beta:
- Calculate the firm's interest expense, net income and EPS at each proposed capital structure and determine which capital structure maximizes EPS.
- Calculate your firm's WACC at each proposed capital structure and determine which capital structure minimizes WACC.
- Explain what capital structure maximizes shareholder value.
- Make a recommendation to your firm's top management team regarding its capital structure.