Ch 16: Assignment - Capital Structure Decisions Back to Assignment Attempts Keep the Highest / 2 11. The relationship between a firm's capital structure and other company attributes Corporations allowed to deduct interest payments as an expense. Corporations allowed to deduct dividend payments to stockholders as an expense. The differential tax treatment of interest payments and dividend payments encourages firms to use in their capital structure. Debt financing is expensive than common or preferred stock financing. Blue Ram Brewing Company currently has no debt in its capital structure, but it is considering adding some debt and reducing the percentage of outstanding equity in its capital structure. The firm's current (unlevered) beta is 1.20, and its cost of equity is 12.40. Because the firm has no debt in its capital structure, its weighted average cost of capital (WACC) also equals 12.40. The risk-free rate of interest (TRF) is 4%, and the market risk premium (RPM) is 7%. Blue Ram's marginal tax rate is 30%. Blue Ram is examining how different levels of debt will affect its costs of debt and equity, as well as its WACC. The firm has collected the financial information that follows to analyze its WACC. Complete the following table. Market debt to equity ratio wa) Market debt to equity ratio ws) Market debt to equity ratio D/S) Bond Rating Before-Tax Cost of Debt ra) Levered Beta (b) 1.20 Cost of Equity (Is) 12.40% WACC 0.0 1.0 0.00 12.40% 0.2 0.8 0.25 A 8.40% 13.87% 12.27% 0.4 0.6 0.67 BBB 8.90% 1.76 16.32% 0.6 0.4 1.50 BB 11.10% 2.46 13.15% 0.8 0.2 14.30% 4.56 35.92%