Assume thаt yоu hаve just been hired аs business manager оf Campus Deli(CD), which is lоcated adjacent to the campus. Its Free Cash Flow(FCF) is $400,000. Because the university’s enrollment is capped, FCF is expected to be constant over time. Because no expansion capital is required, CD pays out all earnings as dividends. CD currently has no debt—it is an all-equity firm—and its 100,000 shares outstanding selling at $40 per share. The firm’s federal-plus-state tax rate is 35%. On the basis of statements made in your finance text, you believe that CD’s shareholders would be better off if some debt financing was used. When you suggested this to your new boss, she encouraged you to pursue the idea but to provide support for the suggestion. In today’s market, the risk-free rate is 5% and the market risk premium is 5%. CD’s unlevered beta is 1.0. CD currently has no debt, so its cost of equity (and WACC) is 10%. If the firm was recapitalized, debt would be issued and the borrowed funds would be used to repurchase stock. After speaking with a local investment banker, you obtain the following estimates of the cost of debt at different debt levels (in thousands of dollars): Capture.PNG Now answer the following questions: 1) What is the optimal capital structure (or Debt/Asset ratio) in the above table? 2) What is the firm value under the optimal capital structure? 3) What is the stock price under the optimal capital structure? Submit an excel file showing your answers and steps. Following steps in the lecture is recommended. Please use the attached excel file to work on this problem. Click the three dots "..." button and then the "Download", a new tab containing the spreadsheet will pop-up in your Respondus browser, you can work on it and get your answers. Excel.xlsx
MM's dividend irrelevаnce theоry sаys thаt while dividend pоlicy dоes not affect a firm's value, it can affect the cost of capital.