Barbara Andrade is an equity analyst who covers the entertainment industry for:

Greengable Capital Partners, a major global asset manager. Greengable owns a significant position with a large unrealized capital gain in Mosely Broadcast Group (MBG). On a recent conference call, MBG’s management states that they plan to increase the proportion of debt in the company’s capital structure. Andrade is concerned that any changes in MBG’s capital structure will negatively affect the value of Greengable’s investment. To evaluate the potential impact of such a capital structure change on Greengable’s investment, she gathers the information about MBG given in Exhibit A.

EXHIBIT A: Current Selected Financial Information for MBG

Yield to maturity on the debt	8.00%
The market value of debt	$100 million
Number of shares of common stock	10 million
Market price per share of common stock	$30
Cost of capital if all equity-financed	10.3%
Marginal tax rate	35%

Andrade expects that an increase in MBG’s financial leverage will increase its costs of

debt and equity. Based on an examination of similar companies in MBG’s industry, Andrade estimates MBG’s cost of debt and cost of equity at various debt-to-total capital ratios, as shown in Exhibit B.

EXHIBIT B: Estimates of MBG’s Before-Tax Costs of Debt and Equity

Debt-to-Total Capital Ratio	Cost of Debt	Cost of Equity
20%	7.7%	12.5%
30%	8.4%	13.0%
40%	9.3%	14.0%
50%	10.4%	16.0%

MBG is best described as currently:

a. 25% debt financed and 75% equity financed.

b. 33% debt financed and 66% equity financed.

c. 75% debt financed and 25% equity financed.

Based on Exhibits A and B, the current after-tax cost of debt for MBG is closest to:

a. 2.80%.

b. 5.20%.

c. 7.65%.

Based on Exhibits A and B, MBG’s current cost of equity capital is closest to:

a. 10.30%.

b. 10.80%.

c. 12.75%.

Based on Exhibits A and B, what debt-to-total capital ratio would minimize MBG’s weighted average cost of capital?

a. 20%.

b. 30%.

c. 40%.

Holding operating earnings constant, an increase in the marginal tax rate to 40% would:

a. result in a lower cost of debt capital.

b. result in a higher cost of debt capital.

c. not affect the company’s cost of capital.