A firm's current balance sheet is as follows:

Assets	$	120		Debt	$	12
				Equity	$	108

A. What is the firm's weighted-average cost of capital at various combinations of debt and equity, given the following information? Round your answers to one decimal place.

 

Debt/Assets		After-Tax Cost of Debt		Cost of Equity		Cost of Capital
0	%	8	%	15	%	%
10		8		15		%
20		9		15		%
30		9		15		%
40		11		16		%
50		13		16		%
60		15		18		%

 

B. Construct a pro forma balance sheet that indicates the firm's optimal capital structure. Choose the best structure from the options analyzed in part a. Compare this balance sheet with the firm's current balance sheet. Round your answers to the nearest dollar.

 

Assets	$	120		Debt		$
				Equity		$

 

What course of action should the firm take? Round your answer to the nearest whole number.

 

Since the firm is currently using   % debt financing, it -Select-(is or is not)at its optimal capital structure and -Select-(should not change the capital structure, should substitute some debt for equity or should substitute some equity for debt)

 

C.  As a firm initially substitutes debt for equity financing, what happens to the cost of capital?

The cost of capital initially -Select-(decreases, increases or does not change)

 

If a firm uses too much debt financing, why does the cost of capital rise?

 

D. If a firm uses too much debt financing, the firm becomes -Select-(more or less) financially leveraged and riskier. This causes the interest rate to -Select-(rise or fall) and the cost of equity to -Select-(increase decrease). These changes in the cost of debt and equity cause the cost of capital to -Select-(increase or decrease)

Answer rating: 100% (QA)

A To calculate the firms weightedaverage cost of capital WACC at various combinations of debt and eq... View the full answer