Now FM Donut Bakery is thinking of changing its capital structure. It's current capital structure is 50% debt and 50% common equity. The company is thinking of changing its capital structure to 70% debt and 30% common equity. Currently, its common stock is traded at a price of $10 per share and the stock is in equilibrium. The company has just paid dividends of $1.10 per share. The perpetual common dividend growth rate is constant at 5%. The risk free rate is 4% and the market risk premium is 6%. FM has bonds yielding 7%. The investment banker estimates that the before-tax cost of debt would be 9% after the change in capital structure. FM's tax rate is 35%.

Required

 How would this proposed change in capital structure affect its WACC?

 Should FM change its capital structure?

Answer rating: 100% (QA)

SOLUTION To determine how the proposed change in capital structure would affect FM Donut Bakerys Weighted Average Cost of Capital WACC we need to calculate the WACC before and after the change and the... View the full answer