Pinder Inc. in the U.S. is examining its capital structure, with the
Pinder Inc. in the U.S. is examining its capital structure, with the intent of arriving at an optimal debtratio. It currently has no debt and has abeta of 1.5. The riskless interest rate and the market risk premiumare is 9% and 5.5%, respectively. Your research indicates that the debt rating will be as follows atdifferent debt levels: D/(D+E) Rating Interest rate0% AAA 10%10% AA 10.5%20% A 1 1%30% BBB 12%40% BB 1 3%50% B 14%60% CCC 16%70% CC 18%80% C 20%90% D 25% The ﬁrm currently has 1 million shares outstanding at $20 per share. Assume corporate tax rate for thisﬁrm is 40%. (a) What is the ﬁrm‘s optimal debt ratio (only consider the above 10 choices ﬁom 0% to 90%). Pleaseuse the cost of capital approach in which you need to check how the cost of debt (using the debt ratingabove) and the cost of equity (using the equation for levered beta) would change at each debt ratio. (b) What is the current market value of the ﬁrm? After the ﬁrm restructures its ﬁnancial structure at theoptimal debt level you calculated in (a), what will be the value of the ﬁrm? Assume that the ﬁrm’sassets are expected to generate a constant annual cash ﬂow forever, which will not be affected byfinancing policy.