ABC is trying to determine its optimal capital structure. The Companyâ€™s capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table: D/V Rating Cost ofDebt 0.1 AA 7.00% 0.2 A 7. 2 0.3 A 8 0.4 BB 8.8 0.5 B 9.6 The companyâ€™s tax rate is 4-0 percent. The company uses the CAPM model to estimate its cost of equity. The riskâ€”free rate is estimated to be 5 percent and the equity market risk premium is 6 percent. Companyâ€™ s estimate of its asset beta is 1.05 Companyâ€™s operating proï¬t (EBIT) is expected to be $2,000,000 in the foreseeable future. Assume no net investInent in fixed assets (only depreciated assets are replenished) and working capital. ABC currently has 1 ,000, 000 outstanding shares.
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3) Reflect on what you have learned about firmâ€™s choice of capital structure in the light of the question above. What other considerations are given in determining capital structure in practice that is not captured in the context of the current question?
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