Rebecca Isbell Optical Corporation is trying to determine an appropriate capital structure. It knows

QUESTION

Rebecca Isbell Optical Corporation is trying to determine an appropriate capital structure. It knows that, as its financial leverage increases, its cost of borrowing will eventually increase as will the required rate of return on its common stock. The company has made the following estimates for various financial leverage ratios.REQUIRED RATE OF RETURN ON EQUITYDEBTDIVIDED BYDEBT + EQUITY)INTERESTRATE ONBORROWINGSWithout BankruptcyCostsWith BankruptcyCosts010.00%10.00%0.108.0%10.5010.500.208.011.0011.250.308.511.5012.000.409.012.2513.000.5010.013.2514.500.6011.014.5016.250.7012.516.0018.500.8015.018.0021.00a. At a tax rate of 50 percent, what is the weighted average cost of capital of the company at various leverage ratios in the absence of bankruptcy costs?b. With bankruptcy costs, what is the optimal capital structure?
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