cyclone software co. is trying to establish its optimal capital struct

QUESTION

cyclone software co. is trying to establish its optimal capital structure. its current capital structure consists of 25% debt and 75% equity; however, the ceo believes thsat the firm should use more debt. the risk-free rate Rrf, is 5%; the market risk premium, RPm, is 6% and the firms tax rate¦
Cost of Equity = Riskfree rate (Market Risk Premium)(Leveraged Beta) 14 = 5% (6%)(Beta leveraged at 25% Debt) Beta leveraged for 25% Debt = 1.5 Unleveraged Beta = (Leveraged Beta)/[1 (1-T)(D/E)] = 1.5/[1 (1-40%)(25%/75%)] = 1.25 Beta¦

leveraged at 50% Debt = 1.25x[1 (1-40%)(50%/50%)] = 2 Cost of equity, rs= Riskfree rate (Market Risk Premium)(Beta leveraged at 50% Debt) = 5% (6%)(2) = 17%

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