# Sapp Trucking’s Balance Sheet Shows

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Answers for 11-12-13 11- Each firm has an optimal capital structure, defined as that mix of debt, preferred, and common equity that causes its stock price to be maximized. A value-maximizing firm will determine its optimal capital structure, use it as a target, and then raise new capital in a manner designed to keep the actual capital structure on target over time. The target proportions of debt, preferred stock, and common equity, along with the costs of those components, are used to calculate the firm’s weighted average cost of capital, WACC. The weights could be based either on the accounting values shown on the firm’s balance sheet (book values) or on the market values of the different securities. Theoretically, the weights should be based on market values, but if a firm’s book value weights are reasonably close to its market value weights, book value weights can be used as a proxy for market value weights. Consequently, target market value weights should be used in the WACC equation. 12- In general, failing to adjust for differences in risk would lead the firm to accept too many risky projects and reject too many safe ones. Over time, the firm would become more risky, its WACC would increase, and its shareholder value would suffer. The cost of capital for average-risk projects would be the firm’s cost of capital, 10%. A somewhat higher cost would be used for more risky projects, and a lower cost would be used for less risky ones. For example, we might use 12% for more risky projects and 9% for less risky projects. These choices are arbitrary. 13- Sapp Trucking’s balance sheet shows a total of noncallable \$45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of \$50 million. The balance sheet also shows that the company has 10 million shares of common stock, and the